After hitting a fresh all-time high, the Nifty50 retraced mildly in the week gone by, and the active participation of bulls at lower levels resulted in a reiteration of the uptrend.
Though the trend is still up, but the momentum indicators are in overbought trajectory, and a bearish candlestick pattern, suggests that upsides from current levels seems to be limited.
Thus, we believe delta appreciating and theta depreciating based “Ratio Call Spread” can be initiated and 1:5 ratio can be adopted. As per strategy, 1 call option can be bought against the short position in 5 call options of higher strike price.
As per current setup, the upside in Nifty50 seems to be limited till 12,400 in an upcoming week. Hence, we recommend buying in 1 lot of 12,350 CE and sell 5 lots of 12,400 CE.
Option chain analysis
Limited upside is visible as per weekly data. Though the Nifty has reclaimed the lost ground and bounced back from lower levels, but fresh short positions has been witnessed in 12,300 CE of more than 4.1 lakh contracts and cumulative open interest has added up to 1,667,025 contracts.
If the 12,300 trades are on the higher side, then short covering rally could extend till 12,400 where call writers hold decent short positions of more than 11.4 lakh contracts. On the other hand, the base for the upcoming week is intact at 12,200, where more than 27.75 lakh contracts are open on the short side in put options, and traders can expect huge unwinding in the same if, the level trades on lower side.
Price patterns suggest that limited upside is expected from the 12,380 to 12,400 range. After forming an indecisive candlestick pattern, retracement in prices has been witnessed, but the fall was capped at 38.2 percent retracement level of the latest swing move.
Though momentum indicators are bouncing back from the support area, they are trading in a slightly overbought trajectory, which suggests that limited upside is expected. A Doji candlestick pattern on the weekly chart suggests that the next leg of rally is likely to take place at a lower pace.
Strategy - Delta appreciating and Theta depreciating based “ratio call spread” (January 2, 20 contract)
Looking at the overall scenario where gradual upside is expected and option premiums are trading with lower implied volatility, we believe traders can form a trading strategy where delta appreciation and theta decay can be obtained simultaneously. Traders can form a “ratio call spread” where 1 lot of 11,350 CE can be bought and 5 lots of 11,400 CE can be sold.
Buy 1 lot of Nifty 12,350 CE at 17
Sell 5 lots of Nifty 12,400 CE at 8
Net premium inflow 23 points.
1) If Nifty closes below 12,350 then profit would be 23 points.
2) Maximum profit - 73 points (if Nifty close at 11,400.)
3) Stop loss and break even – 11,418.
Note: Option prices derived on closing basis as on December 27, 2019.
(The Author is Head of Derivatives at Rudra Shares & Stock Brokers.)Disclaimer: The views and investment tips expressed by investment experts on moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.