Strategy set up – Modified Collar in Bank Nifty
Initial strength in the last trading week in the Bank Nifty was shaved off in the last two sessions and the banking index closed mildly in the red with the loss of approximately 74 points on a weekly basis. The prices are trading near a cluster of medium term moving averages and rising trend line support. The pattern suggests that sideways move in the banking index could continue but mild pullback can’t be ruled out in this trading week.
The multiple support levels present in the 21,600 to 21,400 zone could provide cushion to the prices and mild recovery until 22,300 to 22,500 can be expected in the coming days.
Two consecutive small body candles have been formed in the weekly time frame where the previous week candle has not violated the low of the candle formed in the week ended on August 7. The scenario indicates that even though prices are sideways, the bulls still have an upper hand and multiple support levels can result in a mild pullback in the coming days.
The setup demands a trading strategy where optimum gains can be obtained in an expected limited pullback with capped downside risk. Hence, a modified “Collar” strategy can be adopted for the current week, where long positions in the future can be initiated with short positions in out of the Call option.
To cap downside risk, the long position in near the money Put option needs to be added.
The traditional “Collar” involves the long position in a Put option and the short position in Call option in the ratio of 1:1 against the long position in futures but we have made some modifications to reduce the total outflow and writing a Call option in a ratio of 1:3.
Option Chain analysis
Considering the close of 21,679.40, the Put option of 21,600 and Call option of 21,700 will help gauge trading sentiments in the extremely short term.
The Put option of 21,600 strike price holds a cumulative open interest of 4,500 contracts, whereas the Call option of 21,700 strike price holds the cumulative open interest of 4,551 contracts. The scenario is reflecting the dilemma of the bulls and the bears.
The short-term resistance is shaping up at the 22,000 where the Call option of the same strike price has added fresh open interest addition of more than 12,290 contracts.
The next meaningful resistance exists at 22,500, where the highest cumulative open interest of more than 27,500 contracts is placed at Call option strike price.
The short-term support, on the other hand, is emerging at 21,500 where the Put option of the same strike price holds a maximum cumulative open interest of more than 16,800 contracts. To put things into perspective, the options chain signifies the trading range of 22,500-21,500.
The technical structure is suggesting a mild pullback till the levels of 22,300 to 22,500 as prices are trading near the short-term support zone.
In the August 14 session, prices have taken the support of rising trend line which has originated by joining the recent lows of May 22 and August 3. The cluster of major medium-term moving averages is likely to provide support to prices and could result in a mild pullback. Immediate support is placed in the 21,500-21,400 range that needs to be considered while formulating the trading strategy.
Looking at the overall structure, it is prudent to adopt a trading strategy that can provide decent gains in case of a limited pullback with limited risk. Traders can opt for a “modified Collar” strategy, where a long position in the future can be taken with short positions on OTM CE in the ratio of 1:3. To cap the downside risk, the NTM (near the money) PE can be bought.
Buy Bank Nifty future @ 21,668.80
Buy Bank Nifty 21,600 PE @ 279.05
Sell Bank Nifty 22,500 CE @ 71 (3lots)
Profit booking points – 22,300 and 22,500
Maximum profit 765.15 points (subject to theta decay)
Maximum loss – 134.85 points
Note: Option premium resembles the last trading price as on August 14, 2020 for the August 20 contract.
(The author is Head – Derivatives at Rudra Shares & Stock Brokers Ltd.)
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