Options: Is there a #Brexit play? Uncle Theta explores.

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Uncle Theta - Options - Is there a #Brexit Play - Capitalmind | Active InvestingThe event is upon us and India VIX – a measure of uncertainty in NIFTY’s options market – reached adulthood today, closing above 18. If you haven’t noticed already, implied volatility is a mean reverting beast. And since we’re talking about Brits, perhaps the opening lines from The Beatles song Helter Skelter explains VIX best:

When I get to the bottom I go back to the top of the slide
Where I stop and I turn and I go for a ride
Till I get to the bottom and I see you again

That’s all fine and dandy, but is there a tradable play here? Let’s find out.

We have one week to the June Series expiry and 5m+ Open Interest have been built at 8300 and 8400 Calls, and 8100 and 8000 Puts. With VIX at 18.19, the implied range for 30th June is 8000 to 8400. By selling a June 8100-8300 Strangle and buying a July 7900-8500 Strangle with the credit, you’ll have a defined risk strategy where you’ll stand to make 6.7-7.2K/Lot if Nifty expires between 8100 and 8300 on June 30; with breakevens close to 8000 and 8400 (matching the implied range). Max you could lose, if there’s a big move till June 30 is 15.5K/lot (i.e. below 7300 or above 9200). For a more realistic measure of risk, you’d lose about 7K/lot at 7800 and 8600.

Is there a #Brexit play? - India

But here’s the fun part. Suppose NIFTY does expiry between 8100-8300. You now would have a free strangle for the month of July. If there’s a trending move then, there’s a lot to be made. Considering NIFTY has been in a 231 point range since May 27, it might not be the most foolish idea to assume a trending move follows this compression.

Of course, the other way to play #Brexit is to watch Financial News channels and listen to experts analyse with coin-toss odds what will or will not happen to Indian markets. But, where’s the fun in that?

More on options is available at #strategic-options on our Slack, which is available to all Capitalmind Premium members. If you’re not already subscribed, use discount code GETCM for a 20% discount, valid through June 2016. Our plans start at ₹1,333/mo (post discount). Click here to GET PREMIUM.

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8 COMMENTS

  1. How do you make money with this strategy ?
    At the time of publishing this article the premium from shorting the July strangle was approx 100 rs and the premium for going long on 7900-8500 July strangle was also ~100 rs. Essentially you are long Vol for the July series.

    The article says you make 7k per lot , if nifty expires between 8100-8300 in June series and you get the July long strangle for free .
    We invested the premium received from June leg to go long in the July leg. So how do you make
    7k /lot ?
    This strategy can make money if the volatility spike up, The July longs will have greater value than the June shorts . This is what played out on Friday , Brexit happened and the vols spiked .

    PS:
    I am leaving a comment here because query was unanswered on twitter despite sending a reminder to Deepak/Capital Mind . have you guys stopped taking questions from “non-premium” subscribers or has success got into your heads ?

    • Prices were around 131 (87 on 8100 pe and 44 on 8300 ce) for June and around 133 (82+51) for July. You make 7K because the remaining time value on the July strangle will have fallen to between 90 and 98 in total, and you can exit at that profit on Jun 30. This is an assumption of course, based on IV extrapolation, and the real results may vary.

      Or, you can hold it as a “free strangle” – you’ve already locked in 131 in profit so no matter where the Nifty goes in July, you don’t have a net loss in the July option (since the Jun profit offsets it).

      The fun part is that you can look at it either ways – as a profit in June or a free July strangle, if the Nifty closes in that range.

      Note that it’s already profitable – the July strangle is still at 130 but the June strangle has fallen to 91. Around 35 points or so is the current profit if you exit. That’s about Rs. 2,500 profit per lot, on an investment of around Rs. 100,000 on margin per lot (can assume 150K to keep a buffer). Which is a 1.8% to 2.5% return.

      On this twitter business: This blog post is the right place to ask this question as the context is visible and we can have other people respond too. On twitter there are too many mentions and things get lost in the melee. On the post, visibility is much better. Please refrain from personal attacks.

      • This is exactly what I was trying to say .
        “The fun part is that you can look at it either ways – as a profit in June or a free July strangle, if the Nifty closes in that range” .

        The key here is “OR” , but the article says pocket the money and get the july strangle for free ,which is incorrect .

        The article does not list the scenarios where you could have lost money .
        If there was no brexit , there was 90% chance the market would not have moved much , the July longs would have contracted ( theta decay for OTM options are steep between 45 to 30 days ) .

        • I’m sorry, the article doesn’t imply it’s both. It says “But here’s the fun part. Suppose NIFTY does expiry between 8100-8300. You now would have a free strangle for the month of July.” Which is obvious because the short strangle would expire worthless, and would have thus paid for the long strangle making it “free”.

          And the article also lists scenarios where you could have lost money. Perhaps you missed this part:

          “Max you could lose, if there’s a big move till June 30 is 15.5K/lot (i.e. below 7300 or above 9200). For a more realistic measure of risk, you’d lose about 7K/lot at 7800 and 8600.”

          Now, on the part where you say “if there was no brexit , there was 90% chance the market would not have moved much , the July longs would have contracted ( theta decay for OTM options are steep between 45 to 30 days ).” – This would have been the best case scenario as the theta decay in the June Strangle would’ve been faster than in the July strangle.

          If you’re still willing to debate this further, feel free to call me at 7838336607 and I’ll be happy to respond. Cheers.

        • If there was no brexit, like V has said – the decay on the June options would be MUCH higher. Think about it. You have june options that have 7 days to expiry. You have July options that have 5 weeks to expiry. Both are priced the same today (131 each). Which one would decay more? Even if you consider a volatility smile taper (the deeper OTM options have higher IV so say 22 IV versus 20 IV for the closer to the spot options) the vol smile is still going to be like 19-17, or 18-16 in case of an IV drop. That IV drop won’t make up for the fact that 130 is going to zero in five days (so about 25 points per day); the other one is 130 points in five weeks (35 days) which will do about 5 to 8 points per day, max 10 points per day. In seven days, assuming the Nifty doesn’t move, the Jun options make for more decay than the outer long options.

          (We’ve tested this in more “normal” circumstances – and this is indeed a useful strategy, though you should consider a different set of legs when IV is lower)

          • Yes that is correct , under normal circumstances , the entire 130 premium of june will shrink to 0 ( if 8100-8300 is held ) , and there would be a dip on the July long but not as much 130 , it could shrink to something like 80 or 100 , Hence the net credit would be to the tune of 35-50 rs on exiting the july strangle
            If we continue to hold the July strangle ,just considering the volatility (IVs ) there a 41% probability of the July strangle making money ,
            Or a 41% chance of the complete trade turning profitable, If you chose not to book profit now.

          • The implied probabilities are something I’d ignore now – the actual use will be on how the IV shapes up on Jun 30. But yes, you have the point, cheers!

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