Mumbai: Rich traders aiming to play the Union election outcome on May 23 could initiate a risky Nifty options strategy called long strangle — purchase of an out of the money call and put — which benefits traders by an increase in implied volatility (Vix) ahead of the event and price momentum in either direction after it. Both the options expire on May 30.The buyer of a call and a put pays a premium to the seller. This premium rises as fear gauge India Vix rises. One of the options — call or put — also rises depending on the sharp move on either side ahead of or post the event. The maximum loss to the option buyer is limited to the premium she pays to the seller.For the elections outcome, derivatives strategists such as Amit Gupta of ICICI Direct and Nitin Kedia of Kedia Commodity have advised clients to initiate a long strangle — buy May 30 call at 12500 and May 30 put of 11000. Kedia said buying two strangles (two calls and two puts) to earn from a spike in volatility as measured by India Vix and price momentum of around 6 per cent either side post the event was “expedient”.Analysts expect the Vix to rise from current level of 22 to 35-40 ahead or the results. This is the trend observed before previous election results. In May 2009, for example, Vix surged to a high of 84.93 while in May 2014 it topped at 38.96. Also the two strikes — 11000 put and 12500 call — are equidistant from the current Nifty level of 11,755. They imply 6 per cent movement of Nifty either side for the election results.Long volatility to help tradersAssume the Vix rises from 22 to 40 ahead of the event, the combined value of the options (one strangle) would increase from Rs 115 a share (Friday closing) to Rs 421 a share (75 shares make one contract) as every percentage point rise in Vix changes the options’ price by Rs 17. However, the strangle’s premium falls by Rs 5 with each passing day (theta). Over the 20 days, theta will erode the option price by Rs 100. Thus one strangle premium will rise to Rs 321 from Rs 115, implying a 179 per cent gross return. This makes the other strangle literally free of cost.Kedia suggests booking profit on one strangle a day or two prior to counting. The other one is kept to play for price momentum.After the results are announced on May 23 , the Vix will collapse, reducing the premium of the remaining strangle, but if the Nifty moves by, say, 500 points either side, one of the two options in the strangle will see price rising by at least Rs 75 based on 0.15 delta. What cost Rs 115, will be worth at least Rs 200-210 post the event.
from Economic Times http://bit.ly/2GMl2xo
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