'Considering overall market structure, traders could opt for modified bear call spread'

Chhitij Jain

Strategy setup - Vega and theta-based unconventional bear call spread

Volatility in the last few sessions has reached extreme levels as India volatility Index has propelled till the level of 59.4. Lower freeze in Nifty50 was followed by sharp recovery and such volatile moves have placed the option premium at a highly exaggerated level. Traders can take advantage of high premiums through 'Theta' and 'Vega' decay-based strategy and form unconventional 'bear call spread'.

Strategy involved selling out of the money call option and buying deep out of the money call option simultaneously, further to reduce the costing , deep out of the money put option can be sold.

Chhitij Jain

Head of Derivatives|Rudra Shares & Stock Brokers

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Option chain analysis

Even the sharp recovery after hitting lower freeze the confidence of put writers is not visible in option chain. The quantum of put writing is not satisfactory considering the pace of short covering though some unwinding has been witnessed in immediate call option strike price but bulls are lacking the strength to take the rally forward.

10,300 and 10,500 are emerging as two major immediate resistance levels where significant cumulative open interest can be seen. On the contrary, a major base is emerging at the 9,000-mark where more than 14 lakh positions are open on short side. Overall, data suggesting that bias is likely to be on downside where expected trading range could be from 9,500 to 10,500. The base for current contract is at 9,000 which is likely to be respected.

Technical structure

Damaged technical pattern has shown some recovery on Friday’s trading session but prices are trading below its medium term support level and selling pressure at a higher level is expected. Current recovery should not be considered more than a bounce back from oversold levels.

RSI was trading at the approximate level of 13 (12/03/2020), which is the second lowest level after January 2001. The medium term support was 10,120 which were being held since January 2018 but recent panic has broken the support level and now same level will act as resistance. Sideways movement can be expected in the coming days with negative bias and volatility could be quite low as compared to the last few days.

Trading strategy

Inflated “Vega” in option premium is providing quite clear indication that Vega and theta depreciating strategy can be adopted. Considering the overall market structure, we believe, traders could opt for “bear call spread” with some modifications. Traders can go short in 10,300 CE to gain the premium amount and 10,500 CE can be bought to hedge the position. Further, we are using 8,800 PE in the strategy to be highly cautious and play with the immediate base

EXPECTED LOSS RANGE – 32 to 100 points (If Nifty breaks 9,000).

Strategy would enable the traders to play with volatility with high risk reward.

Note - Option premium mentioned resembles the closing price as on March 13 for March 19 contract.

The author is Head - Derivatives at Rudra Shares & Stock Brokers.