It is an ideal strategy to play in a higher volatility environment when we expect to fall in volatility near the ATM strikes.
Due to global trade war tension and volatile crude oil prices, Nifty50 saw selling pressure which led to a fall of about 3.8 percent on a week-on-week basis. The Bank Nifty followed Nifty50 and was down by 3.24 percent in the same period.
In the week gone by, selling pressure was seen mostly in all the sectors. NBFC, private banking, and steel stocks were the major losers.
Stocks like Vedanta and Hindalco Industries were down by 5-7 percent and among NBFC basket, DHFL tanked 19 percent followed by Reliance Capital which dropped by 13 percent for the week ended May 10.
In the banking space, stocks like HDFC Bank, IndusInd Bank, and YES Bank lost more than 5 percent each. Long unwinding was seen in IT and Auto stocks.
Over the week, major buying was seen in selected midcap stocks such as PC Jeweller as well as Jet Airways which were up more than 16 percent each respectively followed by InterGlobe Aviation which rose 1.5 percent.
Future data of indices depict Long Unwinding in both Nifty and Bank Nifty. If we look at the data, Nifty50 was down by about 3.8 percent and OI was down by 9.5 percent in the same period while Bank Nifty slipped by 3.2 percent and OI was down by 7.2 percent for the week ended May 10.
With the onset of Lok Sabha elections, uncertainty and ongoing tariff war between US and China will lead rise in volatility. India VIX, the fear gauge for Nifty was up by 230 basis to close at 26.33.
The Nifty Option data shows aggressive put writing at 11300PE for weekly expiry (16th May) which could act as immediate support and 11500 CE which has highest OI can act as immediate resistance.
Bank Nifty Option data for the upcoming weekly expiry shows both calls and put are equally congested where aggressive put writing is seen 28500PE which could act as immediate support and 29500 CE which has the highest call OI can act as immediate resistance.
With the confluence of OI seen at both call and put of 29000 along with writers aggressive at OTM call of 29500 and above and OTM puts of 28500 and below indicates Bank Nifty could see a pause in the coming week.
With the placement of higher IVs ahead of the election outcome provide a good reward to risk opportunity in Short Iron Butterfly.
Iron Butterfly is a range bound strategy that offers good risk-to-reward with a credit spread. In this strategy, we need to buy 1 OTM Call, 1 OTM Put and Sell ATM strike of both call and Put.
The maximum profit in this strategy is at middle strike while losses will only be incurred above the higher Call and Lower Put.
It is an ideal strategy to play in a higher volatility environment when we expect to fall in volatility near the ATM strikes. As it is completely hedged strategy one can hold it till weekly expiry (16-May).