Option strategy of the day| Nifty IVs expected to fall post result; use Short iron butterfly strategy

Indian benchmark index Nifty is trading positive to range bound at the start of the June series. Around noon Nifty was trading at 22,522 up 35 points or  0.15 percent.

“Nifty has been trading within an upward sloping parallel channel and now it has just reversed from the upper end of the channel, ” said Jay Thakkar – Head Derivatives and Quant Research at ICICI Securities.

Thakkar believes that the Index is likely to remain in this range as the IVs which have gone up quite a lot due to General Election event are likely to crash post the event.

He recommends a Short Iron Butterfly Strategy on Nifty:

Sell 1 lot of 22500 CE at Rs 433.90
– Sell 1 lot of 22500 PE at Rs 362.80
– Buy 1 lot of 21700 PE at Rs 123.10
– Buy 1 lot of 23300 CE at Rs 108.30

The maximum profit in this strategy is 565.30 points (Rs 14,132.50), while the maximum loss is 234.70 points (Rs 5,867.50). This gives a favorable risk-to-reward ratio of 1:2.40.

Payoff chart of strategy recommended

Technical view

“Since January 2024 Nifty has been trading within an upward sloping parallel channel and now it has just reversed from the upper end of the channel. The range for the Index is 23300 to 21700 levels and the Index is likely to remain in this range as the IVs which have gone up quite a lot due to General Election event are likely to crash post the event, ” explained Thakkar.

Thakkar notes that the current IV of Nifty is 21 and the IVR is at 99.20 for the look back period of 250 days whereas the IVR is at 89.90 for the same look back period. “This indicates that the IV is at the higher levels and in the case of non-event or sideways movement, the Index will settle within 21800-23100 levels which are recent lows and highs respectively. So, to benefit from the theta decay due to anticipated fall in IV, we recommended initiating a Short Iron Butterfly Strategy on Nifty, ” he said.

The Short Iron Butterfly is an options trading strategy designed to profit from low volatility. It involves selling one at-the-money call and one at-the-money put, while simultaneously buying one out-of-the-money call and one out-of-the-money put. This creates a net credit, as the premiums received from the sold options are higher than the premiums paid for the purchased options. The strategy benefits when the underlying asset’s price remains near the strike price of the sold options at expiration, maximizing the credit received. The risk is limited to the difference between the strikes minus the net credit received.

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