Strategy Setup - Modified Bearish Collar Spread in Bank Nifty
Profit booking was witnessed in Bank Nifty in the latter half of the previous week after a sharp up move and the banking index closed only with an approximate gain of 250 points at 21,592.05. After giving a breakout from a trading range on June 23, 2020, prices could not see the follow-up buying and fell again into the trading range.
Bearish candlestick pattern also suggests that the recent breakout might turn out to be a bull trap and extended profit booking can also be seen in the coming days. To trade in the current setup we believe that modified "Bearish Collar Spread" would be an apt strategy where a short position in the future contacts can be initiated with the long position in Call option.
The long Call will act as a protective Call and cap the upside risk in the strategy. Further, to finance the premium paid for the Call option and to reduce the costing of the overall strategy, a deep out of the money Put option can be sold in the ratio of 1:5. This strategy is formed when there is a limited fall expected in the short term.
Option Chain Analysis
As the banking index is trading very close to 21,600, the same strike price will act as ground zero for us. Looking at the overall data, it can be easily concluded that Call writers are having an upper hand and pressure in prices is expected in the coming days.
Looking at the Put Call ratio of an upcoming weekly expiry specifically, it's quite evident that short positions in Call options are quite high as compared to Put options. There are total short contracts of 2,15,429 combining all the strike prices in Call option as compared to only 1,65,800 contracts in all Put option strike prices combined.
The level of 22,000 is likely to act as an immediate resistance where the highest change in open interest can be seen. Short term base for the index is emerging at 20,000 levels as the Put option of the same strike price holds a maximum cumulative open interest of around 20,950 contracts. In a nutshell, data suggests a mild profit booking in the coming days.
Initial rally in the week was abated as the "Bearish Engulfing' candlestick pattern emerged on Wednesday's trading session which was followed by two small body candles. "Bearish Doji" candle that emerged in the daily time frame on April 30, 2020 is acting as strong resistance.
Recently, the banking index breached that resistance level on the upside but instead of trading with follow up buying it formed a bearish candlestick pattern and fell back in the trading zone. This could be an initial signal of a bull trap and could result in a profit booking in the coming days. Trading below 20,900 would confirm the bull trap and in that case, fall could extend till 20,038.
Considering the overall setup we believe that profit booking can be expected this week and traders can form modified "Bearish Collar Spread" to trade the expected limited downside. The short position in futures can be initiated with the protective Call of 21,500 strike price and to finance the long Call, a short position in the 20,000 strike price PE can be taken in the ratio of 1:5. The ratio of 1:5 is a modification of traditional Bearish Collar Spread.
Sell Bank Nifty future @ 21462.15
Buy Bank Nifty 21,500 CE @ 549.80
Sell Bank Nifty 20000 PE @ 85 (5 lots)
Profit booking or Exit range - 20,300-20,000 (depends upon time to expiration)
Expected gain - up to 1337.35 points (subject to theta decay)
Maximum loss – 162.65 points (In case of upside)
The strategy would enable the traders to trade the setup with a decent risk-reward.
To be marked: On Friday, Bank Nifty futures closed at 21,462.15 while spot was closed at 21592. It shows Bank Nifty is trading at deep discount and settlement of options will take place as per spot price on expiry. Therefore, minor difference in maximum loss could be possible.
Note: Option premium resembles the last traded price as on June 26, 2020 for the July 2, 2020 contract.
The author is Head of Derivatives at Rudra Shares and Stock Brokers.
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