Volatility likely to taper off after Budget unfolds

After a firm few sessions, the day of expiry caused a major turmoil in the market last week.

It was the week of rollovers, where apprehension started building since the start of the week. This was evident in the pace at which rollovers were taking place.

Nifty rollovers started lagging the 6-million averages and the gap started increasing as we came near the expiry.

Nifty futures open interest (OI) was slightly below the average levels towards the end of the expiry.

The rollovers, however, did see a boost due to fresh build-up in the March series on the day of expiry, leading Nifty opening participation to over 23 million shares.

This was mainly led by the fresh build-up of short positions through the fall on the day of expiry, indicating that pessimists were creating aggressive long hedges before the Budget.

As far as stock futures are concerned, the rollovers into the March series were trailing the 6 million averages by 200 bps ever since the week started and it ended up with the same gap on the final day of expiry.

The participation in stock futures remained light as the aggregate OI never crossed the 2 billion shares mark convincingly.

Lower rollovers on a lower base has left us with just over 1.67 billion shares in stock futures open interest, indicating a fall of almost 6% in participation expiry over expiry.

Stock futures rollovers saw many sectors losing a fair bit of participation.
Among the stocks that saw month-over-month increment in OI had many of them rolling at below average rollover cost.

The average rollover cost was down this time, indicating more aggression of short rollovers.

As far as options are concerned, the Budget attracted a lot of interest in at the money options. The key reason behind this is the anticipated volatility and an urge to ride the same.

This factor usually takes the implied volatility (IV) factor up, which drives the Option prices higher. Last week saw rise of over 5% in the IVs led by aggressive buying in the Options.  Many of them yielded results as well, making the most of the fall on the day of expiry. Expect the same to continue at least till February 28. As the uncertainty ends, the Option prices will start coming off, led by the lowering of IVs. This week will start with the Union Budget and we may enter the  week with Options trading getting even dearer.

These prices do create very lucrative returns to the writers (sellers), but one should try to restrict themselves on the buying side of the Options only; preferably with long on either kind of the Options.

As the Budget unfolds and clarity emerges, one may start reducing the long Option positions, at least the one against the market direction that persists at that point in time. The reason behind this is, once the uncertainty of the event is out the IVs may start dropping, which will lead to lowering premiums of the Options irrespective of the price of the underlying.

The writer is manager-derivatives at Motilal Oswal Securities Ltd