Over the last week Nifty has plunged 857 points from its high of 11889 and had registered a low of 11023 yesterday. The surprise fall has triggered excessive intraday Volatility and has been the primary cause behind the exponential rise in option premiums. The important question is how can trade options during such excessive volatility?
Take for example, today, Nifty fell almost 190 points from the high and then bounced back more than 200 points from the low. This is a typical high volatility scenario which lacked clear direction. So what is the possible solution?
What exactly is terminal volatility? Terminal volatility is a tool that measures, how much an option premium is likely to expand due to the sudden rise in volatility.
For ease of understanding imagine an elastic band. The band can be stretched and pulled by an external force. However, we all know that the band will ultimately regain its original shape once the magnitude of the external force drops below the force of its elasticity.
In our case, the terminal volatility gauge compares the market volatility with the IV of the option strike and identifies the option strikes to be traded.
11200 Put strike in the 5th March weekly contract was sold and the 11100 Put strike in the 12th March weekly contract was bought.
The process is very simple, first the option strikes are identified by the Terminal Volatility grid to find out whether the premium was above or below normal. A short position was opened in the 11200 Put @79.45 and long position was built in the 11100 Put @ 106, both on the on the 2nd of March. The value of the spread stood at Rs.26.55. This same spread opened at Rs.39 today, when Nifty opened at 11179. Thereafter, when the index plunged 180 points to 11120, the spread clocked Rs42. The position was finally covered at Rs. 66 at the end of the day. There are two bright spots about using Terminal Volatility. It confines the option trade exposure to as low as Rs.26 when option premiums are excessively high and india VIX is at 26. What is even more interesting is, if market had opened 200 points gap down today the maximum risk would have been Rs.10.