India’s benchmark Nifty future registered a high of 12012 today. Today was a good day to understand how ratio traders function. While most market participants were anticipating a buy breakout today. The institutional traders took advantage of the situation and made a smart move. They forced the index to remain inside a range of 75 points after it touched 12000 levels. The question is how did they do it?
The Institutional Spread
You’ll notice, Nifty registered a positive opening today around 11959. The index then registered a high of 12012. Thereafter Nifty slipped into a narrow curvature. The question you want to ask is, “Why Nifty slipped into a range if today’s breakout is true”? Always remember unless the vega expansion in Nifty meets the required criteria, the market maker will use these pop up moves going forward to adjust and the squeeze the option premium in their favour. Today was one such day.
When To Create Spreads
So how do institutional traders understand that they should create spreads? The first thing we must understand is, they create spreads either to eat up time decay or drift along with the shift in market volatility. So the market makers tracks the options vega very closely. We all know that both time and volatility are essential components for the option buyer to generate profits. And that is exactly what they try to offset. This phenomenon is very similar to a time stochastic process where the value of the option premium melts away causing damage to the option buyer’s position. Unless any surprise event is triggered, the market maker has enough room to adjust the position in his favour as time continues to slip away. This is exactly why you’ll notice that the option you buy, sometimes will not generate returns despite trading on the right side of the trend.