FII's aggressively building positions in Nifty to bet on higher volatality

Foreign institutions are aggressively building positions in Nifty options to bet on higher volatility over the next three weeks. These investors are buying Nifty options with the index falling below the 200-day moving average (DMA) -a key sentiment indicator -amid worries about below-normal monsoon, Greece's loan repayment deadline and Fed's monetary policy meeting. A fall below 200 DMA indicates sentiment is weak, which usually results in a jump in volatility.
So far in June, the Volatility Index (Vix), a measure of traders' expectations of near-term risks in the market based on Nifty options values, has surged 8% to 18.12. An advance in Vix indicates the mood has turned jittery. Data in the last 10 years show volatility heightens in June with the Nifty swinging 11% on an average during the month.

"The volatility index may move higher to 21% in June series," said Hemant Nahata, senior derivatives analyst at IIFL. "We have seen FIIs aggressively buying Nifty options over the past few sessions and whenever they have taken this approach the volatility in markets has always risen."

Implied volatility or estimated volatility is a key aspect of options' premium pricing. Premium is the value or price that traders pay to buy an option. When implied volatility rises, options premium also increases and vice-versa.

Nifty options' open interest to Nifty futures' open interest is currently at 6.14 times against an average of 4.6 times in the first week in the last three months. This suggests traders are buying more op tions than futures. Market participants usually buy futures when they are more certain about the direction of the market. In uncertain times, they prefer options because losses are limited to the extent of the premium paid for options buyers. In futures, losses can be unlimited in theory if bets go awry . "Markets have entered the bear phase for short-term, with Nifty trading below the crucial 200-day moving average," said Alex Mathew, head of research at Geojit BNP Paribas. "Nifty may test the previous low of 7,997 as domestic and global environment remain uncertain." The Nifty closed at 8130 on Thursday .

Savvy traders in derivatives market are buying complex strategies such as straddle, strangle, bear put spread, and even bull call spread to profit from the volatility. "We are expecting markets to remain volatile due to monsoon and global events and, hence, are advising clients to initiate -straddle strategy," said Jitendra Panda, chief executive officer at Peerless Securities. "Traders can simultaneously buy Nifty 8,100 call option, and Nifty 8,100 put option to ride the volatility."

Traders can construct strangle strategy to beat the market volatility, where one can simultaneously buy Nifty 8,300 call option, and buy 8,100 put option. Traders who believe markets can decline further can initiate a bear spread strategy where one is advised to buy 8,100 Nifty put and Nifty sell 7900 put, said Mathew.

"We expect broad swings in Nifty with June being an eventful month," said Yogesh Radke, head of quantitative research, Edelweiss Securities. "Nifty 8,000 has utmost importance as a breach below this level may lead index towards 7,750, while upside remains capped around 8,550-8,600."