Mumbai: Bullish HNI clients and proprietary traders have initiated a low cost, long call butterfly strategy on weekly Nifty options with an expectation of the market hitting a new high of 15,400 this week. The record high is presently at 15,257.10.
The target, likely to be tested before or by February 18, is 1.6 per cent away from Friday’s closing of 15,163.3. Rajesh Baheti, MD, Crosseas Capital Services, and Amit Gupta, fund manager, Isec PMS, have suggested the strategy.
It consists of buying a 15,300 call, selling two 15,400 calls and buying one 15,500 call, all of which expire on February 18. Buying calls entails payment of a premium to a call seller while selling calls entails receipt of premium against a margin placed with the exchange’s clearing corporation.
The sale of the two calls greatly cuts the upfront cost of the strategy, but it also caps the maximum upside at 15,400. However, given the strategy’s low cost, the risk-reward ratio is “highly” favourable, said Baheti.
Assuming Friday closing rates, the 15,300 and 15,500 calls cost Rs 75 a share (75 shares equal one Nifty contract), while the sale of the two 15,400 calls fetches Rs 64, cutting the strategy’s upfront cost to just Rs 11 a share.
This Rs 11 is the maximum loss to the strategist and happens if Nifty expires at or below 15,300 and at or above 15,500 on February 18. The maximum profit of Rs 89 happens if Nifty expires at 15,400. Profit begins from 15,311 and runs through 15,400.
If Nifty expires below 15,300, all options expire worthless and the client loses Rs 11 a share.
At 15,400, the 15,300 is Rs 100 in the money, while the 15,400 sold calls expire worthless, as does the 15,500 purchased call. Here the client nets Rs 89.
At 15,500, the 15,300 call is worth Rs 200, while the sold 15,400 calls are worth Rs 200 and the 15,500 expires worthless. The loss is Rs 11.
At 15,600, the 15,300 has Rs 300 intrinsic value, the two sold 15,400 calls are worth Rs 400, while the purchased 15,500 call is worth Rs 100.
“The strategy will make money if Nifty moves upward gradually and volatility declines,” said Gupta. Margins on option spreads were reduced by 70 per cent by SEBI since mid-2020, adding to the “attractiveness” of the strategy, Gupta added.