India VIX is currently at around 20. 20 is considered high VIX, if not very high. It’s great time for option sellers – they get good premiums. But during these times there is going to be an issue. Budget 2016 is coming and this is big news for the markets. So its likely that VIX will not fall too much. Even if it does, it won’t go below 18.
In fact starting next month it will start rising until the budget day when it may fall 10%. I think day before budget it will be at 25 or more and will start falling from the budget day onward.
This is not good news for sellers. If you are an option buyer. This is the best time to do business. But please have a tight stop loss system in your trading plan.
What can sellers do when Volatility (VIX) goes high?
This is a problem traders face worldwide. When VIX is high its great to get good premiums. Due to this traders get lured into selling options only to see huge movements and face losses.
High VIX also means huge volatility, don’t forget that.
So how do you counter huge volatility when VIX is high? Here are some guidelines to help:
1. Since premium is high, reduce the number of options sold. You are getting the same money for taking less risk, why trade more?
2. Warning: Slightly Risky. Sell both ATM calls and ATM puts to get huge premium. This trade is also known as Short Straddle. If you are doing this, trade on a strict stop-loss system.
Lets say if you can afford to lose 20 points – then as soon as you see you are losing 20 points just close the trade. Same with profit booking – book your profits as soon as you get 20 points when you buy back to close. Over a long time this will work. Why? Because option buyers are losers and most of the time sellers win. When you don’t you take a Stop Loss. That’s it. 🙂
If in next 4-5 days there is not much movement and VIX drops by even 2-3% you will get close to 20 points on these two options. Remember that January Expiry is on 28th and there is not much time. ATM options have no intrinsic value, just time value and they have maximum time value than any other strike option. January 2016 options have already entered into the final 10 days. Theta will get very strong here.
For example on 18-Jan-2016 closing basis Nifty is at 7350 and I can see this:
28-Jan-16 CE 7,350.00 99.30
28-Jan-16 PE 7,350.00 82.70
Total premium received is 99.30+82.70 = 182
Sell these two.
Stop Loss will be when the these two become 182 + 20 = 202.
And Profit will be when these two become 182 – 20 = 162.
That’s it more often than not you will profit.
3. Buy more options to cover losses of the sold options. This is a great method if you love hedging. For example you can sell 1 lot of 7350 CE at 99.30 and buy 2 lots of 7500 currently at 36. So basically you still get a credit of 27.30 points. If Nifty expires below 7350, 27.30 points is yours to keep. But if Nifty starts moving up, the 7500 will start bringing double the profit than 7350 sold call losses. You can exit at 20 points profit.
However please understand that this strategy gets risky if expiry is close as you can make a loss in ALL three legs. For example if Nifty closes at 7500, you will lose money in sold options AND lose money in the bought options as they will expire worthless.
So do this when enough days are left for expiry.
4. Try Arbitrage if you have Cash: This is trying to benefit from high VIX when the premiums are high in Futures as well. You can buy a stock in cash and sell its far month expiring Future. For example lets take a high volatile stock whose volatility is high. This is guaranteed profit trade so the quality of the stock or the company does not matter.
See this. The price of HDIL on 18-Jan-16 closing is 65.95.
And see this. HDIL Futures expiring in March 2016 closed at 67.50 on the same day.
Lot size of HDIL is 6000.
So the difference is 67.50-65.95 = 1.55 * 6000 = 9300.
If you close both on expiry day of March 2016 then its a guaranteed profit of 9300 rupees on one lot traded.
Margin blocked will be 66 * 6000 = 396,000. Around 4 Lakhs. Ok the profits are less at around 1% per month – but mind it its a guaranteed profit so even 1% a month is good if its risk free. 12% return in a year without much risk is in my books a great return.
How is the Profit Guaranteed in Arbitrage?
Well its simple mathematics.
Assuming on March 2016 expiry day HDIL is at 100 (best case scenario). Note that on that day premiums from the Futures will vanish and only the intrinsic value will remain.
Profits from cash: 100-65.95 = 34.05*6000 = Rs. 204,300
Loss from the Futures: 67.50-100 = -32.50*6000 = Rs. -195000
Total profit: 204300-195000 = Rs. 9300.00
Assuming on March 2016 expiry day HDIL is at 10 (worst case scenario).
Losses from cash: 10-65.95 = -55.95*6000 = Rs. -335,700
Profits from the Futures: 67.50-10 = 57.50*6000 = Rs. 345,000
Total profit: 345,000-335,700 = Rs. 9300.00
As you can see once the trade is done whatever happens to the stock on the expiry day, you are guaranteed a profit.
But do you really have to wait till expiry?
See this the Futures contract rate of HDIL of the January 2016 expiry:
Its going almost at the same price 66. There is little difference. What does this imply? This means around Rs. 6000 profit in 30 days. I assume after 30 days the difference between the HDIL Future expiring in March 16 and HDIL cash will be only 3000, so essentially Rs.6000 is your profit in 30 days flat. Hey and this is guaranteed profit. 🙂
Lets calculate ROI:
(6000/396000) * 100 = 1.5% guaranteed risk free profit in 30 days. Isn’t it great?
Note: These are possible only when volatility is high. During low volatility times there is not much of a difference between Future premium and cash value of the stock. Arbitrage is only possible when VIX is high.
There was a time when there were plenty of such opportunities in the markets. Unfortunately many traders started abusing the system and market makers reduced these opportunities. Now these arbitrage opportunities are rare but still if you do some research you will find some opportunity in some stock.
For example I searched an opportunity in HDIL in less than 5 minutes. When you are experienced you can easily find these opportunities. Just target volatile stocks.
Remember that its not just 12% return – you can ask collateral against shares and trade a few conservative strategies and try to make more. In my course there is a better conservative stock option trade which is much better than plain arbitrage. The profits may not be guaranteed, but over a period of time we get that. Its not a big deal.
Also note that when you hold the stock you are also eligible for all dividends. These dividends are tax free.
What more do you want?
Arbitrage is STILL ALIVE Big Time in Stock Markets
Have you heard of Hybrid Arbitrage Mutual Funds? You can see a list of arbitrage funds here in value research. Can you see that 1 year return of all the funds is almost same at 7%? Why? Because all fund managers of these funds are doing the same thing. They buy in cash and sell in Futures. That’s it and chew bubble gum till expiry day. Close the trades and make profits for themselves and the investors. Their job is “trying to find out great arbitrage opportunities in the markets”. They take help from systems and huge data that they have. They still make 7% a year. Imagine 7% profits on hundreds of crores of rupees and get 2-3% of the profits. That’s huge for the mutual fund managers, and almost nil for investors. 7% is equal to inflation. So basically they make huge money and return you the same money after few years. You feel you made 7%, in real terms that is ZERO returns but you end up making crores for the mutual fund managers and the fund house. This is an arbitrage in itself.
You can do arbitrage yourself, and fetch much better than 7% a year. You just read how. High VIX are the best times for arbitrage opportunities. Research now you may find better stocks than HDIL.
5. Even the far OTM options will fetch good premiums. For example on 18-Jan-2016, Nifty 7050 PE was going at around 16. After all what are the chances that Nifty will fall that far after already falling almost 10% in just a few days? Time is running out. Even at a slight pull back of 100 odd pints, this 7050 premium will fall to 5 and you can close with a small profit. This is just an example. You can get better premiums in stocks. Of course do this with a strict stop loss system in place. Pease understand that selling naked options is risky and its advisable you do it only when you are experienced in shorting naked options. Else I recommend learn hedging techniques which can reduce you losses, yet give you ample scope to profit.
What do you do when VIX goes high and there is a high chance its going to stay there for sometime?
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