Option Traders Bet on a Range-bound Nifty Play

Investors follow the 'strangle' strategy — sell put at a lower strike price, sell call at a high

   Large traders and proprietary desks of broking firms may have pulled out of the options market, but select investors are taking positions to bet that the Nifty will move within a range for some time. These investors are trying an ageold options strategy known as "strangle". Here, they sell a put option with a lower strike price and simultaneously sell a call option with a higher strike price. They make sure that both options expire at the same time. A strike price is the price at which an investor enters the market. 

As option sellers (or writers) the investors pocket the option premium in the two trades; but it's a high-risk game where they can lose their shirts if the Nifty goes either up or sharply. But if the Nifty moves sideways between the two strike prices, they collect the option premium and lose nothing. It's a "limited profit strategy" that many traders are trying out in an uncertain market. For the past few days, open interest (OI) has been the maximum for 5700 calls and 5500 puts. 
On Monday, call writing (selling) was seen in 5700 calls which saw a 7% increase in open interest. On the put side, a short build-up was seen in 5500 levels with an 5.5% increase in open interest, respectively. This indicates traders are making short strangle and short straddles and expect the market to trade in a range of 5500-5800. 
"We are suggesting our clients to establish short strangles as the Nifty is expected to trade in a range with credit policy announcement round the corner," said Shailesh Kadam, AVP-Institutional Derivatives, PINC. "We expect the Nifty to trade in the range of 5500-5800 in the near term as higher inflation and uncertainty in European markets will limit the upside in the Nifty," he said. 
Traders said many broking firms are selling call options with a strike of 5700 and put options with a strike of 5500 on the lower side. This is known as "short strangle". It means traders don't expect the market to break out of this range till the expiry of July series. 
PROP TRADES TAKE A KNOCK 
Having lost money in options, proprietary trading desks of most broking houses are refraining from such bets. Indeed, the participation of proprietary traders in options has been falling consistently due to a dull market and little movements in the implied volatility index (or vols). (Traders buy vols when they are betting that the market will be choppy). 
Derivative analysts said that a range-bound movement in the Nifty, following a sharp rally mainly driven by institutional investors, have prompted prop traders to stay out. "Prop volumes in options have fallen nearly 30-40% in the past one month as there has been no movement in implied volatilities (IVs)," said Adil Setna, Head-Derivatives, Dolat Capital Markets. "Also, the current IVs are not justifying the movements in the Nifty, making it unviable for traders to sell options," he added. 
Implied volatility, a measure of traders' expectations of nearterm market risks, is a key aspect of option premium pricing. 
But analysts, including Manoj Murlidharan, AVP-Derivatives, IIFL PReMIA, said that many proprietary traders were caught off guard when the Nifty surged from 5200 levels to 5800 due to buying by institutional investors.