Pre-Budget Derivative Strategies for Traders

The upcoming Union Budget may have announcements that may cause increased volatility in the markets. Traders who understand derivatives well may benefit from this increased market volatility. For such traders our recommended derivative strategy is:

Long Butterfly strategy

1^st Leg : Buy 1 lot NIFTY 23000 CALL at Rs 474 (6^th Feb expiry)

2^nd Leg : Sell 2 lots NIFTY 23500 CALL at Rs 220 (6^th Feb expiry)

3^rd Leg : Buy 1 lot NIFTY 24000 CALL at Rs 74 (6^th Feb expiry).

Maximum Risk Reward ratio of this strategy is 1:3.63

Upper breakeven point of this strategy is 23892

Lower breakeven point of this strategy is 23108

Maximum profit of this strategy per lot is Rs 29,400 if Nifty 50 closes at 23,500 level. Maximum loss per lot of the strategy is Rs 8,100.

Approximate Margin requirement for implementing this strategy is Rs 77,000

Long butterfly spread strategy involves buying 1 call at a lower strike price; selling two calls with a higher strike price; and buying one call with even a higher strike price. Now in this long butterfly strategy you will buy 1 lot of Nifty 23000 Call option at an option premium of Rs 474. You will also sell 2 lots of NIFTY 23500 Call option at an option premium of Rs 220. And you will also buy 1 lot of Nifty 24000 Call option at an option premium of Rs 74.

Rationale for this recommendation

The above strategy reflects a moderately bullish outlook. In the options segment, aggressive put writing is being seen at 23,000 level for options with 6^th February expiry, suggesting a strong support.

The FIIs’ long-to-short ratio in index futures has improved to 0.33 from 0.19. This is the highest level of this ratio since December 23. This indicates that FIIs may be covering their short positions.

Current implied volatility (IV) of index options is at 23%. This is higher than the 5-year average IV of 20.6%, two days before a budget. Historical data of the past 12 years shows that IVs drop significantly on the day of the budget. If this trend is followed this year too, and IVs decline on the budget day, then it will favor the Long Butterfly strategy. Nifty 50 is therefore expected to remain in the range of 23000 – 24000 until 6^th Feb.

Disclaimer : Investment and trading are subject to market risks and other risks. There is no guarantee regarding the outcome of any investment or trade recommendation.