A lot of folks have reached out to me during the past few days to have an update on my Bloomberg Quint story How Option Traders Beat Budget Uncertainty published on 05 Feb 2019.
Here, you go!
There’s usually uncertainty in the market in the run-up to a budget and predictably so the implied volatility bid higher as we move towards the event. However, once the event jitters are over, implied volatility mean reverts to a more meaningful level.
Trend Following
And, you know what? Budget days often proved to be a deciding factor for the market direction and risk-averse traders prefer to use option strategies to trade in the direction of the underlying trend and any trend follower will seldom miss this opportunity.
One strategy that has paid off in the past is to buy at-the-money straddle of Nifty index option close to the end of the budget day with more than 20 days to expiry.
The analysis shows the average return of this strategy was more than 0.72% per trade — as a percentage of Nifty level at the close of the budget day — for the last 14 years with maximum gain and loss of 6.21% and 3.82% respectively.
Cumulatively, this strategy has generated more than 22% in the month following the budget during the nine positive years while losing around 12% in the five negative years with a positive expectancy of ~ 65%.
There were only 66 months when Nifty Index ranged between +/- 2% in a month — that’s 32% of all months since 2005. Thus, there is a 68% chance of Nifty moving beyond this range following the event, increasing the probability of straddle being in the money.
Why Enter at close of the Budget Day?
Historically, 90% of the time, India VIX recorded a fall post the budget. The median drop in India VIX on the close of the budget day is 1.71% and 2.45% until the following monthly expiry day. The lower the premium paid, the better the profitability would be for the trend follower.
The February expiration at-the-money straddle is currently quoting around 3.83% of the underlying price as at end of Feb 1, 2022.
P.S: My data analysis further reveals very interesting trends and trades on index strangles and straddles, but that’s a story for some other day.
