India’s benchmark Nifty witnessed a catastrophic fall of 4000 points from the recent high of 12418. In today’s session, Nifty Futures crashed to a low of 8299 in the first 20 minutes of trade. The unprecedented collapse in the past few sessions had triggered an exponential rise in the market volatility and today it forced the exchange to halt trading for 45 minutes.
In today’s article we shall discuss about how we can skilfully trade options when VIX is unnaturally high. There are umpteen number of possibilities for option traders who can calculate the shift in market volatility and not revert to blind predictions. In our last article also we had discussed about the use of Terminal Volatility when market is hit with exponential rise in India Vix.
India VIX At 59
It is important to keep in mind, that India VIX at 59 is an extremely rare phenomenon, therefore historical reference of charts during these times is pointless. The most important step is to find a way to neutralize the excessive volatility. Simply put, excessive volatility means options are over –priced, hence buyers and sellers move in and out swiftly, causing whipsaw moves of 300-350 points in a short while. The goal is to create a position that can reduce the risk and will squeeze money from option buyers who have bought into excessively high premiums.
Hedge Against High Volatility
We all know that Nifty Future opened approximately 650 points gap down today. When market opened after the trading halt, you could either trade a call or put option without the need to know the direction. You ask yourself, “Is the volatility normal or abnormal?” In today’s scenario, there was no way you could tell that Nifty would bounce back. But we knew that volatility was abnormally high. This also meant that option buyers were buying exponentially high premium. So this was an opportunity we wanted to catch. So we were looking for mispriced options.
Selection Of Option Strikes
Option traders are generally looking for a direction, they hardly ever bother about the volatility and its impact on the options gamma. This where the opportunity was hiding today. Market spiked almost 300 points after the trading halt. This is the area when VIX was at 59. We knew high volatility would not allow you the luxury of fair valuation to option buyers. Markets were choppy and the Terminal Volatility gauge was showing that the pricing of 10400 Call in the 19th March contract was flawed. So we sold the 10400 Call for 19th March @ 99 and bought the 10400 Call in the 26th March contract @154. This is an intelligent way of taking advantage when VIX is high. The spread value was created @Rs.55. Notice that we were selling an overpriced Call when market was zooming up and buying another strike with a longer duration till expiry. As nifty climbed, the spread squeezed the excess premium from the bloated up march 19th Call option. The spread was later booked at 89 when Nifty was around 10000 approx. There are two big advantages of trading options by adjusting volatility. Firstly, the reward component is extremely good and consistent. Secondly, there is a low possibility of getting stopped even when 300 points move in either direction in Nifty is a normal phenomenon.