Put option writers caught on wrong foot as Nifty plunges

With the Nifty tanking close to 10% in January, close to 74% of out-of-the-money put options ended without getting squared off. This is no surprise given that most of the out-of-the-money options (whether call or put) end without getting exercised since they are worthless. However, the number of options that end unexercised has declined from an average of 95% to 74% of total options in the month of January. Many options writers who sold the put options were seen making losses this time.

According to Girish Patil, manager-derivatives at the Antique Stockbroking, ?This trend of out-of-the-money option ending without exercise on expiry basically highlights the difference between the type of traders that buy and sell the options. Generally hedgers form a majority of the set of option buyers while most of the option sellers are market professionals who are ready to take the risk of unlimited losses?.

In some instances this decline in per cent of out-of-the-money option ending unexercised also indicated a strong market trend ( in this case bearish) and the same was fairly priced in by option traders.

It could be difficult to spot any trend in extent of out-of-the-money options that end without getting exercised as it could also be an effect of an option trading strategy practiced by experienced option traders,? added Alex Mathews, head-research, Geojit BNP Paribas Financial Services.

According to him, in the recent scenario if a trader holds a bearish view on the market, he could be buying Nifty 5,300 puts while selling out-of-the money Nifty 5,900 calls which would add up to the open interest of the out-of-the-money calls.

Options writers are that segment of traders for whom the maximum profit out of an option trade is the premium paid by the option buyer. Moreover, unlike the option buyers, for the writers the maximum loss can be unlimited, especially if the market moves drastically against their favour.

A put (call) option is said to be in-the-money for the buyer when the underlying index or security trades below (above) the strike price of the option so as to cover more than the premium paid by the buyer of an option.

There are two ways options writers, who face an unlimited risk, try to get out of this situation. One, they can square off their positions and buy back what they had sold. Second, they can sell Nifty futures but this entails an additional cost. ?Generally they prefer to square off their positions and move to a lower strike price,? said Savio Shetty, research analyst ? institutional derivatives at Prabhudas Lilladher.