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Optionalysis: Election Fever - Which Options To Sell, Which Options To Buy?

Deepak Shenoy4 min read
Quick Facts
What is "Optionalysis: Election Fever - Which Options To Sell, Which Options To Buy?" about?
What category is this article in?
Premium
Who wrote this article?
Deepak Shenoy, Capitalmind's research team.
When was this article published?
Published 28 April 2014.
How long does this article take to read?
4 min read
What does the "Strategy: Buy Lower Priced, Sell Higher Priced?" section say?
One way to trade these options is to buy the lower IV options and sell those that have a higher IV. This is risky, and involves serious application of cash, around 10-15 lakh in order to justify enough diversification.

This is a Capital Mind Premium post, sent on April 24, 2014.

Elections are here! Or at least, the results will soon be. Anticipating a lot of volatility we are seeing stock and index options trade at very high premiums. In fact the Vix is at 33.36, reflecting the very high premiums option writers are demanding for the month.

We’ve seen before that what matters also is that Implied Volatility of a Straddle. After some quick programming, and rustling up some old code, we now have a calculator that shows you Option Implied Volatilities for every single stock or options. Until our online tool is ready we will present this as a table.

The Straddle is simply the options with a strike price nearest to the stock price. The Call and the Put will give us an idea of how volatile the stock is expected to be.

We’ve taken stocks and indexes that have some liquidity (the straddle, Put+Call, should have traded at least 50 contracts). The Call and Put prices are added up to find the **Straddle Range **(the option straddle price as a percentage of the stock price)

This is described in detail in our earlier article: Estimating Implied Moves Using Straddle Ranges.

We have also calculated the Implied Volatility of the Call and the Put on the straddle and thus, the “average” volatility. Here’s what they look like for the two most traded indexes.

No other index seems to have liquidity.

Now, let’s look at the top stocks that have liquid options, ranked by their implied volatility.

Apparently the Adani stocks are expected to be most volatile with three among the top few. The implied moves in a single month is 20%! Remember though that some of these stocks have nearly doubled in two months, so there is a chance the stocks actually move quite a bit.

The Real Estate pack is quite active. Unitech, DLF, JP Associates and IndiaBulls Real Estate are seeing IVs of over 57.

Strangely, we see three banks in the list and one NBFC (Reliance Capital).

Looking at the stocks that have the LOWEST implied volatilities:

United Spirits (MCDOWELL-N) is heavily traded and has the lowest implied volatility on board. This could be because of range compression as the stock has an open offer going on and isn’t expected to deviate too much from the 2800 price.

The Tech pack (INFY, TCS, Wipro, HCL Tech, Tech Mahindra) all come in with low volatility expectations. This again is a little strange, because the elections can swing the rupee a fair way. It may be useful to buy these options (or deeper OTM puts and calls).

Most of the FMCG lot are not very volatile and voila, the relatively low straddle ranges and option implied volatility show that.

There are pharma entries (Sun Pharma, Lupin, Dr Reddy, Cipla) which are again surprising because they aren’t unaffected by elections.

To give you a large list, we’ve attached the full table below. It’s an image, but if you’d like it in a Google Document for Premium members, please let me know and we’ll provide it.

Strategy: Buy Lower Priced, Sell Higher Priced?

One way to trade these options is to buy the lower IV options and sell those that have a higher IV. This is risky, and involves serious application of cash, around 10-15 lakh in order to justify enough diversification.

In certain common sectors it might make sense to be short a straddle on one stock and long another. For instance, the Canara Bank stock has a straddle range of 13.9% while HDFC Bank’s range is just 8.75%; a pair trade would be to buy a HDFC Straddle, and sell a CANBK straddle for the month.

Another useful way is to combine this list with individual stock resistances or supports; however in a massive election move, hardly any known supports or resistances work. It will be better to take on a hedged trade instead of a naked one.

Here’s the full list:

Note: We’ll send in a separate mail about a webinar we will have on Saturday (11 AM) on How to Read an Annual Report. Please do keep yourselves free, and recordings will be available.