Indian Union Budget will be presented on 29 Feb 2016 , and as discussed in previous post Nifty remains in a wide range so there is an opportunity to trade in Nifty Options And the opportunity could turn out to be quite promising.
Which will be market direction post budget we do not know so its best we take a position that is completely independent of the direction of the market and possibly make money out of it.
Though we don’t have an idea of the direction, historically, the maximum change in Nifty from the budget date to the next expiry date is quite decent in either direction. So, we can fairly assume that the move post budget is going to be big as it always is. So lets discuss the Option Strategy
Long Straddle strategy
A long straddle strategy is when you buy a Put Option and a Call Option of the same expiry and at the same strike. As most of retail investor will prefer trading the Option Route to trade ( They should not trade but still they cannot resist the temptation of not trading ).Yeah, offcourse, there could be a loss. There is nothing called ‘100% probability of profit’ in stock market. But, definitely we can identify strategies with bear minimum losses and with a good potential of profit.
The above depicts the Vitality and Range Expansion Nifty has witnessed in past 18 Budget session.Just by going at the sheer number its looks mind boggling. So Stop Losses are must for traders on Budget day. Traders who are weak heart and cannot digest the bout of volatility you are going to witness just stay away from market.
So Following Option Strategy can be used to play the Budget day:
A long straddle is the best of both worlds, since the Call Options gives you profit if Nifty goes up and the Put Options gives you Profit if Nifty goes down at a particular strike price . But those rights don’t come cheap, because as the Budget day come nearer Implied Volatility of Nifty Options will rise which in turn will increase the price of Options.
As soon as the event is over the IV will come down drastically and there will be huge fall in Option Premium.
The goal is to profit if the stock moves in either direction. Typically, a straddle will be constructed with the call and put at-the-money ie. Suppose Nifty is trading at 7000 so trader will eye on 7100 Call and 7100 Put . Buying both a call and a put increases the cost of your position, especially for a volatile stock. So you’ll need a fairly significant price swing just to break even.
By having long positions in both call and put options, straddles can achieve large profits no matter which way the underlying stock price heads, provided the move is strong enough.
- Price of Underlying – Strike Price of Long Call – Net Premium Paid
- Strike Price of Long Put – Price of Underlying – Net Premium Paid
- Max Loss = Net Premium Paid + Commissions Paid
- Max Loss Occurs When Price of Underlying = Strike Price of Long Call/Put
- Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid
- Lower Breakeven Point = Strike Price of Long Put – Net Premium Paid
Lets discuss with an Example
Suppose Nifty is trading at 7000 . An options trader enters a long straddle by buying a March 7100 PE for Rs 185 and a March 7100 CE for Rs 146. The net debit for the trader is 331+ Commissions (185 +146 ), This is the maximum loss for the trader per lot. The position will be profitable if Nifty changes by more than 5% at expiry date.
- Nifty is trading at 6700 on expiration in March, the March 7100 Call will expire worthless but the March 7100 Put expires in the money and has an intrinsic value of Rs 400 . Subtracting the initial debit of 280, the long straddle trader’s profit comes to Rs 69, thats a profit of 20% on capital employed.
- Nifty is trading at 7450 on expiration in March, the March 7100 Call will expire in the money and has an intrinsic value of Rs 350 but the March 7100 Put expire worthless . Subtracting the initial debit of 331, the long straddle trader’s profit comes to Rs 19.
- On expiration in March if Nifty is still trading at 7100, both the March 7100 put and the March 7100 call expire worthless and the long straddle trader suffers a maximum loss which is equal to the initial debit of Rs 331 taken to enter the trade.
For a traders their is no Thumb rule that he need to keep position till Expiry even before expiry if trader is seeing profit in the position can exit the trade.As IV’s of PE is very high so once Budget speech is over, traders can build position at that point of time.