Markets
Option sellers baking in 8% swing in Nifty on election D-Day
Summary
During such events traders' anticipation of wild swings raises prices of both call and put options. This, in turn, results in a spike in fear gauge India VIX, which has rallied 88% this month to 24.18 as of Thursday.Mumbai: Option sellers are baking in an almost 8% price swing in Nifty on Tuesday when results of the 18th Lok Sabha elections will be announced, according to National Stock Exchange data. This shows the extent of cushion the sellers, who are exposed to unlimited risk, are piling on in anticipation of wild swings that day, according to market analysts.
This is borne by the combined price of the weekly 22500 strike call and put options contract expiring on 6 June at closing on Thursday— ₹865 a share (25 shares equal one contract). This is the price that option sellers have charged buyers of the 22500 call and put option—straddle in market speak—which works out to a total 7.7% range (22500-865 and 22500+865) to cover their risk in the event of sharp price movements.
Read more: In a market segment with its ear to the ground, apprehension is rising
For context, the Nifty swung 427 points (4%) between intraday high and low in the previous Lok Sabha election result day on 23 May 2019 and 433 points (6%) during the results for Lok Sabha 2014 polls on 16 May 2014.
During such events traders' anticipation of wild swings raises prices of both call and put options. This, in turn, results in a spike in fear gauge India VIX, which has rallied 88% this month to 24.18 as of Thursday.
Nifty options expiring on 6 June are the most actively traded with total call open (outstanding) positions at 13.58 lakh shares and total put open positions at 11.17 lakh shares. NSE offers four weekly expiries every month). This was the data available Thursday after the expiry of the May series of futures and options contracts.
"There has been short formation in the derivatives space where some retail investors seem to have taken contra positions to speculate on the election event," said A. Balasubramanian, MD & CEO, Aditya Birla Sunlife AMC.
Bala, as he is known in market circles, said that mutual funds being "long-only" use the derivatives segment only for hedging and warns retail investors against speculation on market moving events which can subject them to huge losses.
He added that there was a "high probability" of the Bharatiya Janata Party "bettering" its 2019 seat tally of 303 in the current round of elections.
Read more: LIC stock is available at a discount. So why aren’t investors piling in?
Despite this expectation volatility as reflected by VIX has risen massively this month, especially ahead of the election results week. For instance, Nifty swung 6% from a low of 21,821.05 on 13 May to a record high of 23,110.8 on 27 May, only to shed 2.7% (622 points) to close at 22,488.65 on Thursday.
Option sellers tend to charge a lot more from buyers ahead of such events, according to Chandan Taparia, SVP (head derivatives & technical research) Motilal Oswal Financial Services.
"A 7-8% move is what is being priced in by option sellers on 4 June as a matter of abundant caution," he said.
Read more: Indian companies warm up to dollar debt as hedging costs drop
Option sellers' maximum gain is the premium or price received from option buyers, but their losses can be unlimited. In the case of buyers, the maximum loss is the price paid to the option seller, but gains are unlimited.
Kruti Shah, quant analyst, Equirus, said strong support lay at 21700 while she expects resistance at 23300 levels until the results are declared.
