Bank Nifty option sellers may face a double whammy if RBI holds interest rates

MUMBAI: With a desire to gain from high options prices, overseas P-Note traders, brokers’ prop desks and short-term punters have taken certain bets which could potentially backfire if the RBI holds interest rates steady at Tuesday’s policy meet and makes comments perceived to reflect more gloom than cheer, derivatives analysts said. These constituents have, ahead of RBI’s policy on Tuesday, sold bank shares in the cash market and purchased bank futures. Against this, they have also sold Bank Nifty call and put options to pocket the high prices, or premiums, of these options.

Their bet is that RBI will cut the rate at which it lends to banks by 25 basis points (bps). Once the RBI action becomes clear, options' volatility and price would fall, forcing the option buyers to square off at a loss. Or, in the rare event of RBI cutting the repo rate by a much larger 50 bps, the net increase in the value of bank stock futures and premium gained from the sold put option would outweigh the rise in the call option premia, making sellers net gainers.

The positions that have seen substantial buildup are the 18000 Bank Nifty put, priced at Rs.220 on Tuesday, and the call option of 19000 priced at Rs.288 – giving the seller an inflow of Rs.508. So long as the Bank Nifty does not move in excess of 508 either up or down, the sellers won't lose. The Bank Nifty futures closed down 0.7 per cent at 18,639.7 on Monday.

However, derivatives analysts do not rule out a fall in excess of 500 points in Bank Nifty in the current series if the RBI holds rates steady and paints a gloomy picture of inflation and the economy amid prospects of a below normal monsoon. If this does indeed happen, Bank Nifty option sellers would, in the words of Manoj Vayalar, derivatives analyst at Religare, be hit by a "double whammy" of falling stock futures and rising premiums of Bank Nifty puts.

"The fall could be much higher than the Rs.508 they earned writing the call and puts," warned Vyalar. "It's what's called a shark bite strategy in derivatives parlance, because when a shark bites, nothing much remains."

However, Anand James, co-head, technical research at Geojit BNP Paribas Financial Services, feels a sharp swing either side is unlikely because the open interest or traders' outstanding positions are not high enough to merit this. Traders' outstanding positions rose by a little over a lakh shares to 3.2 lakh in the 18000 put and 60,800 shares in the (3.2 lakh) in the 19000 call.