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Upcoming Union Budget 2022: F&O Trading and Risk Management Strategies you Should Note to Manage Risks Better

18 Jan 2022 0 COMMENT

The Union Budget of India, also referred to as the Annual Financial Statement in Article 112 of the Constitution of India, is the annual budget of the Republic of India. The Government presents it on the first day of February so that it could be materialized before the beginning of new financial year in April.

Indian Stock markets have witnessed high volatility during most Union Budget announcements in the last 10 years.

With High volatility, comes risks and opportunities. In this article we will discuss popular F&O Strategies traders adopt and how can one manage risks better while maximizing returns.

Let’s start with History

The average Intra-day movements in the last 10 budgets have been around 2.9% in Nifty and around 4.3% points in Bank Nifty. In the last Budget, market rallied more than 4% in a single day for Nifty while Bank Nifty rallied over 7%. Below graph shows the year wise movements in points for both Nifty and Bank Nifty for last 10 years.

Source : NSE Bhav Copy

How have Option Prices moved over the last few budgets?

The table below shows the Option Prices in the last 3 budgets considering the budget day as the “At the Money’ strikes. Pre-Budget IVs gain due to uncertainty of the event and as soon as the budget is over the IVs shrinks specially on the side against which market is moving.

 

Call Option Premiums

ATM Strike

Put Option Premiums

Year

14 days before

7 days before

1 day before

Near ATM Strike on Budget Day

14 days before

7 days before

1 day before

2021

323.5

230.6

38.4

14300.0

299.5

248.3

657.2

2020

524.8

510.0

22.7

11700.0

92.8

19.9

46.9

2019

194.1

150.9

201.4

11800.0

105

121.8

37.4

Source: NSE Historical Contract-wise Price Volume Data

What are the various Option Strategies to play the Budget? How do we manage risks better?

Straddles and Strangles are both common options strategies that allow an investor to benefit from significant moves in a stock's price, whether it moves up or down. The difference is that the strangle has two different strike prices, while the straddle has a common strike price.

A long straddle is an options strategy that involves purchasing both a long call and a long put on the same underlying and same strike price. A long strangle consists of one long call with a higher strike price and one long put with a lower strike.

The risk is that the market may not react strongly enough to the event or the news it generates. The premium paid becomes your risk.

You can check your pay-offs with ICICIdirect and execute these strategies at a Click with new Basket Order.

Source: ICICIdirect Payoff of Long Strangle Strategy

Butterfly is another strategy used by traders when they want constant payoffs across any market condition. The standard Butterfly is a three-legged strategy which can be implemented as here:

  1. Buy a Call option with high strike price (a.k.a wings)
  2. Sell two Call options of lower strike price (a.k.a body) and finally
  3. Buy a call option at even lower strike price (a.k.a wings)

Now, the maximum risk in the strategy for the trader is he/she might lose the entire premium paid in case the market is highly volatile and goes beyond the wings. However, in case the market ranges between the wings, then the maximum benefit for the trader is the gap within the strikes – cost of premium paid

The maximum risk in this strategy is that if the market are highly volatile and goes beyond the wings, then the trader may tend to lose its entire premium paid. If the market tends to range between the wings then the maximum benefit is the gap within the strikes - the cost of premium paid.

You can check your pay-off using Pay-off analyser and the margin using Basket order. The Margin required to deploy such strategy is around 42,000 with ICICIdirect as opposed to 194,000.

Source:ICICIdirect sample pay-off chart for Long Butterfly

I am an Option Seller; how do I hedge my risks so that I don’t lose a lot of money if there is a sharp move.

Options sellers benefit from decay in Option Prices, but run the risk of losing a lot if there is a significant run in the market. One of the popular cover strategies is to buy Out of the Money options above / below the Options you have sold. This ensures protection and costs of deep OTMs options are cheaper. Though it reduces profitability, but also reduces risks and hence margins on the position.

The margin requirement changes from Rs 219,000 to nearly Rs 70,000 because of the hedged position

Source: ICICIdirect sample strategy for Iron Condor

I trade in Futures. How do I protect my risks and reduce margin requirement?

Futures traders benefit from 1 delta i.e. increase in futures prices as the price of underlying moves unlike ATM or OTM Option traders who run risk of time decay.

However, futures trading come with a higher downside risk. One of the simpler ways to hedge Futures contract is with Long options.

Suppose you expect markets to rally ahead of budget. If you go long in Nifty and buy a Nifty Put option, your position is hedged and your maximum loss will be the strike of put option and price at which you went long in Futures.

The margin requirement also comes down significantly. It reduces from nearly Rs 1.1 lacs to Rs 42k and downside becomes limited.

Source: Snapshot of ICICIdirect Basket Order

Trading in Futures and Options have inherent high risks and hence risk management is most critical here

Disclaimer:-

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