India’s benchmark Nifty witnessed an astonishing recovery of 168 points in today’s session. Although the index opened 68 points gap down at 10960, it surprised the sellers and closed with confidence around 11064. Today’s upswing is yet again a strong reminder that it pays to remain trend neutral at all times. Derivatives’ trading becomes smooth if we understand the 2 cardinal rules.
1. Understand how Greeks are positioned.
2. If you are a buyer, think like the seller and vice versa.
The Gap Down
In today’s session, Nifty opened 68 points gap down around 10960. Interestingly, the gap down opening neutralized the covariance factors in the Put options. At this juncture, the institutional traders bought a specific Put strike in the weekly contract. Keeping in mind the neutral covariance in the Put and the position of the market maker, we bought the same Put strike. However, Nifty bounced back sharply and the institutional traders squared off their position at a drawdown of Rs.6/lot. By now we were down Rs. 6 per lot. The next step is to wait for the market maker to make his next move.
The Bounce Back
We had discussed in the past that institutional traders build positions based on solid mathematical systems. This means that the market is likely to witness sharp swings if the institutional positions are challenged. Take for example today’s move. The market makers bought Put options in the first half. The position was wrapped up after a drawdown of Rs.6. Next, they waited for the 11100 Call gamma and vega in the weekly contract to neutralize. When Call strike arrived at the binomial price, they executed a trade again. The 3 hallmarks of this trade were zero emotion, super professional approach and stringent discipline. We followed the market maker and bought the same Call. @Rs41. Nifty scaled up to a high of 11094. The Call strike registered a high of Rs.76. It was later squared off at Rs.64. The Call trade fetched Rs20 per lot. The net gain was Rs14. Overall; the market makers had another fruitful day, by sticking to their trade discipline.