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F&O traders suggest Iron Butterfly strategy

The strategy has a risk-reward ratio of around 2.5:1, which makes it attractive.

, ET Bureau|
Oct 09, 2018, 08.18 AM IST
Banking on a potential decline in implied volatility (Vix) levels from the current 20.14, brokers are advising their ultra-rich clients to initiate an iron butterfly (Ironfly) on weekly Bank Nifty options. The strategy has a risk-reward ratio of around 2.5:1, which makes it attractive. As volatility declines, option premiums reduce, which enables the clients to pocket the premia paid by the option buyers.

The Bank Nifty closed on Monday at 24,618.35. The traders are hoping the Bank Nifty expires at this level to earn a profit of Rs 285 a share (40 shares equal one lot) or Rs 11,400 at the contract level. The maximum loss is Rs 4,600 at contract level.

Derivatives head Amit Gupta of ICICI Securities and Rajesh Palviya of Axis Securities are advising clients to sell two at the money (ATM) options and purchase two out of the money (OTM) options. The premiums of the ATMs being higher than that of the OTMs, the Ironfly results in a net credit to the client.

The strategy is a combination of a bear call spread and a bull put spread. It involves the sale of a 24600 call (Rs 257 a share) and purchase of a 25000 call (Rs 93). Simultaneously, the client sells a 24600 put (Rs 215) and purchases a 24200 put (Rs 94). All options (40 shares equal one lot) expire on October 11. The Bank Nifty closed at 24,618.35 Monday.

The maximum profit is the net premium earned, or Rs 285 a share. The loss is limited to the difference between the ATM and OTM options minus the net premium earned, or Rs 115. The maximum profit happens if the Bank Nifty closes at 24,600 on expiry.

Traders Suggest Iron Butterfly
The upper breakeven point (BEP) above which the client begins to lose is at 24,885 (24600+285) and the lower BEP kicks in at 24,315.

The loss is limited to Rs 115 in either case as the client has purchased an on-the-money (OTM) call (25000) and an OTM put (24200).

Gupta says that in the past two years whenever the Vix has hit 20-21 levels, it has reversed from there towards 15-17 levels. This decline causes the options premia to drop and the client to benefit from the fall since she is a net seller.

YES Bank
Interesting F&O activity was witnessed on YES Bank. Two large clients held over 3 per cent of the bank’s market-wide position limit (36.9 crore shares) on October 4. Client 1 held 3.85 per cent and Client 2, 3.05 per cent.

The price of YES Bank near month futures ended up 1.4 per cent at Rs 216.25 on October 4. On October 5, Client 2 squared off his entire position while Client 1 raised it to 4.12 per cent from 3.85 per cent. On that day, the price of the share dropped 4.2 per cent to Rs 207. On Monday, the price of the futures jumped 7.5 per cent to Rs 222.8 a share (1,750 shares make one lot).

While it’s hard to speculate on the nature of these positions, the reaction of Client 1 to the change in price on Monday would be interesting to see when the exchange updates data on Tuesday.

Also Read

View: An iron butterfly offers good profit potential

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