Aaryan Magan is a 17-year-old student from Kolkata, India. Having been involved in capital markets since the early age of 13, he has been able to gain considerable hands-on experience in such markets. He has gained a deep understanding of the intricacies of the field. His particular areas of interest include stocks, derivatives, and cryptocurrency.
Over the years, one financial instrument that piqued his interest was options. This interest led him to develop a strategy, which is a variation of a Short Strangle for NIFTY 50 options contracts. To understand what an options contract is, let us have Aaryan explain it himself: “Let us understand this with the help of an example. For instance, you buy a property in an industrial area that is yet to be developed. After a few years, when the development of the industrial area is completed, you list your property for sale and notice that the value of your property increased by manifold. What just happened? Your property’s value was derived from the condition of the industrial area around. ‘Options’ work in a similar way. They derive their value from an underlying asset, which in this example was the industrial area. There are usually two types of options: ‘calls and puts’. A call’s value would usually increase if the value of the underlying asset increased, whereas a put’s value would usually increase if the value of the underlying asset decreased.”
Aaryan hopes that the readers now have a basic understanding of what an options contract is and shall now move on to explaining the strategy he developed:
My strategy involves short selling a slightly OTM (Out of the Money) call and a similar put having the same weekly expiry, depending upon the status of INDIAVIX (A Volatility Index). The reason for choosing INDIAVIX is that it gives us an overall view of the volatility expected in a market, thus giving us an idea of how the NIFTY 50-- a prime market index-- is going to move. Lower values of INDIAVIX imply lower volatility in the market. When I correlated these lower levels of volatility with prices of NIFTY 50 options contracts, I made an interesting observation: the gamma component, which tracks the rate of change of the delta of an underlying asset, was affected adversely implying a low rate of change in delta. However, this low rate of change doesn’t imply a stable price due to a factor known as time decay, and that is exactly what can be taken advantage.
In market periods when INDIAVIX is low, we can short sell such contracts to obtain the premium and close our positions at a point when the value of these options becomes almost nil due to time decay. Using this strategy, there have been instances where nearly the entire premium has been obtained as profit. A necessary safeguard for this strategy is a strict stop loss-- in case things go wrong due to a sudden shift in the market.
To conclude, a time when this strategy could have been used effectively would be the period of consolidation in the market from mid-June to the end of July. On 18th June, INDIAVIX stood at a low level of 10.6125. During this time, the market was range-bound, and consequently, INDIAVIX hit quite a few lows as well.