Some prop firms beat low volatility by selling weekly bank Nifty puts

MUMBAI: A class of proprietary firms is raking it in even as most derivatives traders find making money increasingly difficult with low volatility, measured by India Vix, which has halved from its 52-week peak of 23.1 last November to about 11-level, currently.

Over the past few months, many prop traders have moved away from simply selling writing options on Nifty to weekly Bank Nifty contracts launched last May.

These prop firms, which are bullish on markets, write or sell deep out-of-the-money (OTM) put options on Bank Nifty with weekly duration. The weekly options series commence each Thursday.

The smart traders sell the options around the be ginning of the new series (Thursday) and square off by Monday. In the bargain, they earn an average 2.5 per cent monthly return or 30 per cent annualised.

An option seller benefits when the premium (option price) he collects from a buyer falls. The two important determinants of an option's price are time decay (theta) and volatility. Every passing day eats into an option's price as does a decline in volatility. The smart option sellers time the selling of put options when volatility is high and the impact of time decay is minimum. They can thus command higher price (premium) from buyers.

The two-day weekend causes time decay to eat into the weekly option's price at a faster rate than longer duration Nifty and Bank Nifty and just after that the option price invariably declines, benefiting the sellers.

For instance, Mayur Poddar, director, Markethub Stockbroking, sold an OTM, 23000 put option on weekly Bank Nifty expiring June 15, last Wednesday at Rs 35 a share (40 shares =1 lot). The intraday price of that option on Tuesday was Rs 4.7, meaning Poddar had pocketed almost 90 per cent of the premium paid by the buyer.

Poddar wrote the 23000 put when the spot Bank Nifty was close to 23600 last Wednesday. Even when the spot Bank Nifty shed 220 points from its close last Friday (23690) to 23470 on Monday, the price of the 23000 put closed at Rs 11, way below Poddar's selling price.

“That was the impact of the theta,“ Poddar said.

Chandan Taparia, head of derivatives research at Motilal Oswal Securities agreed. “It's the theta that's attracting bulls to extend their play from Nifty to the weekly Bank Nifty .“

The value of the Bank Nifty is two-and-a-half times that of the Nifty .A comparison of the intraday volumes of the 9400 and 9500 OTM Nifty puts and weekly Bank Nifty puts from 23400 to 23000 illustrates this shift.

Against combined volumes of the two Nifty OTM puts of 1.65 lakh contracts, the five OTM puts on Bank Nifty expiring on June 15 were 3.99 lakh contracts. All figures are intraday. The same applies to the call options.

A put option seller is bullish that an underlier will not fall below the strike price sold minus premium received from buyer for it. A call option seller is perceived as bearish as he feels that an underlier won't rise above a strike plus premium received from a buyer.

Foreign institutional investors and DIIs are usually buyers of index put options while prop houses and clients are net sellers. The margin to write options is around 15 per cent of the notional value multiplied by the premium into 40 shares (1 contract).This is considerably higher than the premium that the buyer places.