India’s benchmark Nifty futures triggered a sharp upswing of 200 points today. Today’s up-move was a magnificent example of option mispricing. Although news headlines in the morning screamed “Asian shares jumped to a three-month peak as Wall Street hit all-time highs”, we shall talk about how the institutional traders managed their positions based on mispricing of options on the background.
The Vega expansion
Today’s rally was an intelligent move by the market maker. To understand this, we must look into what they did towards the beginning of the October expiry. The institutional traders had created spreads to neutralize the uneven vega expansion in the options market towards the beginning of the October contract. The question is what caused this uneven expansion in the options vega?
The Sitharaman Impact
If you watch closely, Nifty was bursting with confidence in the last few days of the September contract due to Finance Minister Nirmala Sitharaman’s tax sops. Nifty had zoomed up 700 points in a single day between 10700 and 11400. The explosive nature of that move caused the implied volatility in certain strikes in the October contract to rise. The institutional traders took advantage of the uneven expansion in options implied volatility.
The Spread Effect
Today morning, that same spread was wrapped up after 20 days of trading. Positive news was splashed all over at the same time to make it look like a trigger . The unwinding of the spread triggered massive mispricing in some Call option strikes. One of the strikes was 11800 Call option. A major advantage of capturing options mispricing is, it pinpoints the entry points at low risk zones. Take for example the 11800 call option today. The institutions entered the call when it was at Rs.10. This is an extremely smart move, as the net risk now is just Rs.10. Based on the institutions; the 11800 call was bought @ Rs.12. Then Nifty zoomed up and the call registered a high of Rs72. The position was later squared off at Rs.51.