Strategy Setup - Modified Bear Call Spread in Bank Nifty
Fireworks continued on the Street as bulls extended the rally and Bank Nifty propelled by more than 2,200 points in the week gone by. The banking index witnessed one-sided up move after breaking the recent intermediate high of 23,211.35 formed on July 22, 2020 and bullish exuberance remained intact throughout the week.
The Marubozu candle on Friday's trading session reflecting the strength of bulls and indicating that room for further up move is still left. Though, the banking index is approaching its major resistance levels but further limited upside might not be ruled out in the coming trading sessions. The range of 25,223 - 26,234 is likely to act as an important zone for the banking index in the forthcoming trading week.
During the panic selling in March, the prices have formed the "falling window" or a gap at the aforementioned levels and now the banking index is approaching toward it for the first time. Also, traders need to keep in mind that the prices are trading in an overbought zone. Generally, it is difficult to trade the important resistance level on the higher side in one attempt; traders can expect a profit booking in the banking index once the gap area approaches.
Steam is still left for further upside and profit booking can be expected anywhere from 25,223 to 26,234 range. The base is developing at 23,000 level which is likely to provide a cushion to the prices on every dip and the short term trend will remain bullish until the level trades on the lower side on a closing basis.
The setup needs a trading strategy that could absorb a further limited upside and provides a return in profit booking as well. Hence traders can adopt a modified "Bear Cll Spread" where out of the money (OTM) Call option can be sold and deep OTM Call option can be bought to hedge the position.
The strategy can be improvised further by initiating a short position in deep OTM Put option to take advantage of theta decay and increase the total inflow.
Option Chain Analysis
As per the current close of 24,523.80, the banking index is at the money (ATM) at 24,500 strike price. The change in open interest in 24,400 PE is approximately 4,900 contracts where the open interest addition in 24,600 strike price CE is around 5,850 contracts.
The data is not indicating any major move on either side. The immediate resistance is shaping up at 25,000 level as the Call option of the same strike price holds a maximum cumulative open interest of approximately 23,200 contracts. The next expected resistance is emerging at 25,500 level where more than 11,600 contracts have been added on the short side and cumulative open interest has reached at 21,578.
On the other hand, short term support is emerging at 23,500 level where put option of the same strike price holds a cumulative open interest of around 29,500 contracts. There is a decent cumulative open interest addition in 23,000 level as well and it could act as intermediate support in an upcoming week. The option chain signifies the trading range of 25,500 to 23,000.
The rally was extended after breaking the resistance levels of 23,212. The "Shooting Star" candle formation on July 8 and negative candle formed on July 22 was acting as resistance for the banking index for the past few days. The breakout above these candles recently has resulted in a decent up move and the same breakout level is likely to act as a support in the coming days.
The 38.2 percent projected retracement level as per the last trading week range is 25,580 and 61.8 percent projected level on downside exists at 22,823. The banking index is likely to trade between these two levels in the coming days.
Considering the above points, traders can expect the banking index to trade in the range of 25,500 to 22,800 approximately. Traders can trade the setup by adopting a modified "Bear Call Spread". The strategy could fetch return to traders if it is traded in given range.
Sell Bank Nifty 25,600 CE @ 85
Buy Bank Nifty 26,000 CE @ 40.05
Sell Bank Nifty 22, 000 PE @ 17 (2 lots)
Expected profit - 78.95 points (subject to theta decay)
Stop loss for downside - 22,000 as per spot level.
Note - Option premium resembles the last traded price as on August 28 for the September 3 contract.
The author is Head - Derivatives at Rudra Shares & Stock Brokers LtdDisclaimer: 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.