Traders are resorting to selling options at low implied volatility (IVs) in the belief that Indian equities will continue to stay rangebound. However, some of their strategies seem to have backfired, as those who have sold 5,400 puts recently have incurred huge losses, derivatives experts say.
In the last 10 days, traders are selling the 5,400 puts despite low IVs of 16-17, expecting that the Nifty won?t breach 5,400 on expiry.
?If implied volatilities are low, one goes long on options, if it is high you sell options. That is what should happen theoretically. However, practically right now people don?t expect the market to go anywhere. Therefore, they are selling options at low IVs,? says Savio Shetty, institutional derivatives analyst at Prabhudas Lilladher.
According to Shetty, this strategy can backfire because even a small dip of 20-30 points in the Nifty can result in a mark-to-market loss.
?Those who have sold 5,400 puts recently have incurred huge losses. The only way out for them is to either square off positions or sell Nifty futures for hedging,? he said.
When IVs are low, the option seller gets to pocket a small premium but faces unlimited risk if the market tanks. On Friday, the Nifty closed at 5,366.4.
The Nifty volatility index or VIX has stayed put at around the 20 level for almost three months now.
According to Siddarth Bhamre, head of derivatives, Angel Broking, IVs have not gone up significantly despite a significant correction due to the absence of sharp movements or widespread panic.
What is interesting to note is that in India, various bull and bear phases have had their own range of IVs.
?In the past, Nifty has risen even when the IVs were at 30-40 levels whereas at present the Nifty is falling even at low IV levels of 16-17,? said Shetty.
India VIX seems to be mirroring global volatility trends. For instance, the Chicago Board Option Exchange?s CBOE Volatility Index, based on S&P 500 Options prices, has remained at the 20 levels for nearly three months now.
In fact, it breached its 21-year mean of 20.34 on Wednesday for the first time since March 21, according to data compiled by Bloomberg.
VIX is popularly known as the fear index and measures investors? perception about the risk of sharp swings in the market.
India?s VIX had touched a high of 85% in November 2008 in the aftermath of the global financial crisis.