(Bloomberg) — A key options trade particularly popular in India to bet on volatility on the day equity derivatives expire showed an unusual pattern on Tuesday, highlighting a potential trading opportunity as market players grapple with a new mechanism for determining closing prices.
The price of the at-the-money straddle, in which a trader simultaneously buys or sells both a put and a call, on the expiring NSE Nifty 50 Index options climbed late in Tuesday’s session. Since contracts become worthless at expiry, the straddle’s value should typically drop gradually to zero during the day.
The introduction on Monday of an auction at the end of the trading day has sparked sharp moves in the Nifty 50, whose official close in the past two days differed significantly from its level at the end of the continuous trading session at 3:15 p.m. Mumbai time. Such price gaps could create opportunities, according to Mumbai-based Vishal Mehta, an independent trader.
“A long straddle just before the closing auction becomes attractive when you expect the auction itself to create a meaningful price dislocation,” Mehta said. “You don’t need to predict the direction — only that the equilibrium price will land far enough from where the market is trading at 3:15 pm, that’s it.”
The index close is now determined at the end of the auction process, by 3:35 p.m., while derivatives still settle at 3:40 p.m. Traders are now bracing for more discrepancies on Thursday, the day options tied to the BSE Sensex Index expire on the smaller bourse BSE Ltd.
“Tomorrow could be even more volatile,” said Varun Khandelwal, founder of prop trading firm Bullero Capital. “Given the already limited participation in BSE cash trading — and the even thinner participation in the auction session — closing prices could diverge meaningfully from those on the NSE, creating scope for sharp and potentially unpredictable moves around expiry.”
(Corrects attribution in the last paragraph.)
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