The negative divergence on the daily chart has played its part and resulted in a mild drop in prices and traders now need to wait for a fresh signal to determine the next leg of the rally.
Strategy Setup – Theta Depreciating based 'Iron Butterfly' in Bank Nifty
As expected, Bank Nifty traded with negative bias throughout the last week and witnessed a limited fall till support level. The negative divergence on the daily chart has played its part and the banking index closed with a weekly loss of more than 1,000 points.
Prices are trading near important support levels and in the current week, traders can expect a subdued movement in the banking index. Friday's trading session is providing an initial signal that fall could be abated at these levels as the bulls reclaimed the lost ground and showed decent recovery from lower levels and formed a 'Hammer' like pattern. The pattern suggests that bears have booked profit at lower levels and mild correction has completed.
Though further weakness is not expected but there is no signal either which suggests that bulls could take the charge once again as prices are facing the resistance of short term moving averages ribbon. It seems prudent to go for neutral strategy and traders can trade the current setup with help of theta depreciating based 'Iron Butterfly' strategy where at the money Call and Put option can be sold to gain the premium amount in the form of theta decay and out of the money Call and Put option of equal distance can be bought to hedge the positions.
The strategy provides a decent return in the sideways market with low risk and high reward.
Option Chain Analysis
Considering the recent close of 21,640.05, the Call option of 21,700 strike price and Put option of 21,600 strike price will play an important role in determining the extremely short term trend. The cumulative open interest in 21,700 strike price CE is 5,961 contracts, which is marginally higher as compared to total open interest in 21,600 strike price Put option of 4,700 contracts.
The data is not indicating a significant bias on either side. The first significant resistance is emerging at 22,000 level where the Call option of the same strike price has added more than 10,900 contracts in open interest and cumulative open interest has reached at 24,937 contracts. On the other hand immediate short term support is shaping up at 21,500 level where Put option of the same strike price holds a significant cumulative open interest of more than 13,400 contracts.
In a nutshell, the subdued move is expected as per the option chain in the coming days.
The recent fall has been arrested at medium term moving averages ribbon and prices formed a 'Hammer' like pattern on Friday's trading session. The prices are taking support at the rising trend line, which is originated by joining the recent lows of June 16 and July 16.
In the coming days, we can expect the price to move in the range of 21,350 to 22,000 as momentum indicators are trading in the sideways zone with a neutral curve. The negative divergence on the daily chart has played its part and resulted in a mild drop in prices and traders now need to wait for a fresh signal to determine the next leg of the rally. Until then, the banking index is likely to trade in a narrow trading range.
Considering an overall setup, it's quite apparent that traders can opt for a theta depreciating based neutral strategy. We have opted for 'Iron Butterfly' for the forthcoming week where Call and Put option of ATM strike price can be sold and simultaneously Call and Put option of OTM strike price can be bought.Sell Bank Nifty 21,700 CE @ 385
Sell Bank Nifty 21,700 PE @ 370
Buy Bank Nifty 22,200 CE @ 168
Buy Bank Nifty 21,200 PE @ 182
Maximum profit - 405 points
Maximum loss - 95 points
The strategy would provide maximum profit if Bank Nifty expires at 21,700. A strategy is flexible enough to provide decent gains even before the date of expiry and hence, safe traders can also book profit whenever strategy shows the profit of 200 to 250 points during the week.
Note - Option premium mentioned resembles the closing price as on July 31, 2020 for the August 6 contract.
The author is Head - Derivatives at Rudra Shares & Stock Brokers Ltd.Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.