Chhitij Jain
Strategy Setup – Modified Covered Call in Bank Nifty
Bulls are not ready to take the back seat and celebration on the street remained intact in the week gone by. Initial profit booking got arrested on Thursday's morning season which was supported by follow-up buying on the last trading day of the week. The rally was led by banks and financial and Bank Nifty formed a pattern which can be termed as reversal after retracement. The fall was arrested at a 50-day exponential moving average and prices formed a bullish candlestick pattern with long lower shadow on Thursday's trading session indicating that bulls have taken over the game again after a mild profit booking.
Bulls are likely to extend the journey till the latest previous top (23,080.60) formed on July 8, 2020. To trade the setup, traders can deploy a 'covered call' strategy with some modifications where long positions in futures can be initiated and out of the money Call option can be sold to gain the premium in form of theta decay. Traditional covered call contains one short Call against one long position in the future but in the current case, we are modifying the ratio from 1:1 to 1:3 where three Calls can be sold against one future. It would reduce the costing of overall trade and enable the traders to take advantage of expected rise in price and theta decay simultaneously.
Option Chain Analysis
At the money Call option of 22,000 strike price holds cumulative open interest of more than 25,000 contracts and apart from this there is no significant open interest visible until 22,500 strike price where more than 13,000 contracts have been added in open interest. Data suggests that if 22,000 level taken out on the higher side, there could be a smooth journey till 22,500 and then 23,000. The level of 23,000 can be used as a profit-booking point as the same strike price Call option holds maximum cumulative open interest of more than 26,000 contracts. Looking at the support with the help of Put options data, the first significant fresh open interest addition can be seen in the 21,500 strike price where more than 14,300 contracts have added on the short side and total open interest has reached at 21,474. The maximum total open interest in Put option is placed at 21,000 strike price and it can be seen as a short term base.
Technical Structure
Technical structure is favouring the bulls as prices have formed a bullish candlestick pattern on Thursday which is quite identical to the bullish 'hammer'. The formation was supported by follow-up buying in the next trading session indicating reversal after retracement in the banking index. Short term moving averages are developing a positive curve and bullish crossover can be seen in momentum indicators. Momentum is building up in an intraday time frame also where prices have started tagging the upper Bollinger band in a 15-minute time frame and RSI is trading in a positive zone. Immediate support level is placed at 21,570 and 21,397 which is 61.8 percent and 100 percent Fibonacci projected level of Friday's trading range. The journey on an upside can be expected till 100 percent projected level of the same aforementioned range which is 22,530. As bias is on upside, the bulls can take the rally toward the recent high of 23,080.60 also.
Trading Strategy
The overall setup is suggesting that limited and gradual upside is expected in the banking index till 23,000 odd levels in the forthcoming week. Traders can trade the setup with modified 'covered call' where long positions in the future contract can be taken along with short position in OTM call options in the ratio of 1:3.
Buy Bank Nifty future @ 21,971.10
Sell Bank Nifty 23,000 CE @ 89 (3 lots)
Profit booking points - 22,530 and 23,000
Stop Loss for future - 21,390
Maximum expected gain - 1,295.90 points (if contract expires at 23,000)
Expected loss - 314.1 points (subject to theta decay, if Stop loss triggers at 21,390)
Strategy would enable the traders to take advantage of expected rise in price with decent risk reward.
Note - Option premium mentioned resembles the last trading price as on July 17 for July 23 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.
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