As Nifty falls in the sinkhole, the trap is getting wider for Put writers

Put writers are those who have a positive outlook on the market. They sell put contracts to buyers with hope that the market will move higher and thus they will get to pocket the premium. Though such writers theoretically carry unlimited risk.

In the last six sessions, the market has moved in a direction. The Nifty 50 is down over 4 percent and has now fallen below the 19,900 level. Bank Nifty in the same period has fallen more than 5 percent. The move has come as a boon for put option buyers who tend to benefit when the market moves in a certain direction, however, the same move is becoming an albatross around put writers’ necks.

Put writers are those who have a positive outlook on the market. They sell put contracts to buyers with the hope that the market will move higher and thus they will get to pocket the premium. Though such writers theoretically carry unlimited risk.

The sharp sell-off in the market started on October 18, however, the intensity of the sell-off was not that high. This was despite turmoil brewing in West Asia, giving hopes of a recovery later. The burgeoning US bond yield put a spanner in the works and the selling got worse in subsequent days.

Thus, those Put writers, who were losing some money in the initial days and did not book losses, suffered more. They had to keep adjusting their positions lower in the hopes that eventually the market would bounce back, lifting their fortunes. Alas, it never materialised!

“What has happened is that put writers have kept shifting their positions in the hopes of covering the losses. In the past, this has worked when the market was not moving much but now it has resulted in a trap,” said Ankush Bajaj, a Raipur-based derivatives trader.

What is more, rising VIX in the last few days gave the cushion to Put writers to employ such a risky strategy. A rise in the India VIX levels leads to higher option premiums, which in turn provide some cushion to stay with their position for a while longer.

“There are two things that are happening. The rise in premium provided a cushion, giving Put writers courage. Apart from that a number of supports between 18,800 and 19,200 also filled them with confidence,” said Santosh Pasi, a Mumbai-based derivatives trader.

Also read: Rise in volatility index makes traders jittery. A sharp directional move in Nifty may be coming

A support, in technical parlance, is that level where market-wide traders have created a lot of positions. Thus these positions start acting as hindrances for indices to move smoothly. Such levels are usually the inflection points for an index to either change its direction.

Analysts have been touting 18,800, the gap of 18,850 and 18,900 and 19,000 levels as big support for the market. On October 26, the Nifty closed just above 18,850 one of the support zones for the index.

Very likely, this may give additional confidence to traders that may turn fatal.

Bajaj agreed that such behaviour, that is, selling fresh puts when you have been suffering losses is not wise behaviour. One needs to understand that the market is always right and often it is better to book losses than keep falling for the same mistakes.

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