Implied volatility seen subdued in January; experts suggest selling Nifty calls

MUMBAI: Implied volatility — traders’ expectations of near-term risks in the market based on options prices — has fallen and could remain subdued in January giving an opportunity for investors to make money.

Proprietary traders and a few HNIs are selling (writing) Nifty options contracts these days on expectations that risks of a sharp move in the market are low immediately with the US Fed going ahead with its rate hike. Implied volatility is a key aspect of pricing of options’ value; when it rises during times of uncertainty, option premiums go up and vice versa.

Volatility Index, which measures traders’ expectations of near term volatility using Nifty options’ order book, plumbed 21 percentage points from December 15, a day before the rate hike, to 13.74 on Thursday. Over the same period the Nifty gained 2.1% to 7,861.05.

Prop traders who sold a December Nifty 7800 call and put option — a straddle in derivatives parlance — for a combined Rs 215 a share (75 shares = 1 lot) on December 15 are currently sitting on a mark-to-market profit of Rs 111 a share The price of the straddle is expected to fall further as the December series of derivatives expires in four days. Closer to expiry, rising time decay eats into an option’s price.

Greater interest in selling options is evident from the increase in the traders’ outstanding positions, or open interest (OI), amid a fall in option prices.

Proprietary traders’ outstanding net sales of index call options have risen since the Fed event from 1.36 lakh contracts to 1.47 lakh. Net outstanding index put sales have jumped from 97,860 contracts to 1.37 lakh contracts.

IIFL’s derivatives expert Hemant Nahata advises selling a strangle (a call and put of different strikes) in December to gain from the falling premiums and using the proceeds to part fund a January strangle.

“Traders will pocket the premia for selling a Dec 7750 put and 7950 call. They can do a calendar spread by buying a Jan 7750 put and 7950 call. If either call or put rises till Dec expiry on 31st, they will be hedged by the long strangle,” Nahata said.