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Sell a strangle on Bank Nifty to play RBI policy

The lower breakeven below which losses start is 1.9 per cent from Monday's close.

, ET Bureau|
Updated: Aug 02, 2017, 08.30 AM IST
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The lower breakeven below which losses start is 1.9 per cent from Monday's close.
The lower breakeven below which losses start is 1.9 per cent from Monday's close.
Traders wanting to bet on RBI's interest rate action could initiate a short strangle before the central bank's decision. The strategy involves selling a call and put option on Bank Nifty weekly contract expiring on August 3. It assumes a range-bound move in the underlier, which is what enables the seller to make a profit.

The ground for the strategy being vended by most derivatives analysts to their clients is that a 25 bps rate cut is pencilled in by the market. Such a cut would cause the Bank Nifty to rally by around 100150 points, less than the 462-point cushion the seller has either-side from the sell level of 25,100.

The second scenario is a 50bps cut, which few consider likely. This could result in a much sharper rally, by 400 points or more. Lastly, maintaining status quo would result in a correction of not more than 400-odd points, reckon the analysts.

Keeping the three likely scenarios in mind, Amit Gupta, derivatives head at ICICI Securities, says clients could sell a 24,700 put and a 25,500 call expiring August 3. Both the options were around 400 points away from spot Bank Nifty's close at 25,123.

At Monday's close, the 24,700 put was Rs 21.5 a share (40 shares make a contract) while the 25,500 call was Rs 40.45. Selling both, would net the seller Rs 62 a share. That's the maximum profit, which occurs if Bank Nifty closes any level between the two strikes.

Since markets have more or less priced in a 25bps cut, analysts feel even if RBI cuts the repo rate by that extent, the market would not rally above 25,562 (25,500 plus premium received by the seller) at least till expiry on August 3.

Even if RBI leaves the rate unchanged, the Bank Nifty would not fall below 24,638 (24,700 minus the premium netted by the seller). The upper breakeven above which the seller begins to lose money is 1.74 per cent above Monday's close. The lower breakeven below which losses start is 1.9 per cent from Monday's close.

This means a 25bps cut isn't likely to cause the Bank Nifty to rise above 1.74 per cent or holding rates wouldn't cause the index to fall more than 1.9 per cent, allowing the strangle seller to keep the Rs 62 a share premium.

However, Mayur Poddar of Markethub Stockbroking, cautions that a 50 bps cut could push the Bank Nifty above the upper breakeven and result in substantial losses unless a stop loss is placed at the start of the trade. "In such an event a 500-point rise in Bank Nifty is probable," said Poddar.

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