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Options strategies for the upcoming budget

Mike Akeroyd.jpeg

8 min read | Updated on July 22, 2024, 09:51 IST

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SUMMARY

Historical data shows mixed reactions on Budget Day, with the NIFTY50 averaging a 0.3% return. Market participants anticipate sharp swings ahead of the Union Budget announcement on July 23, followed by the expiry of futures and options contracts on July 25. Strategic options trading can help navigate potential market volatility.

Budget 2024: NIFTY and BANK NIFTY strategies for July 23

Budget 2024: NIFTY and BANK NIFTY strategies for July 23

The financial markets are driven by news, and when major news events occur, the markets will take notice. When a company announces its financial results each quarter or if there is a change in interest rates, index and stock prices will likely move. This is no different with the Union Budget. As information that impacts various sectors is released, investors and traders will adjust their portfolios to account for potential future increased (or decreased) opportunities.

While you can’t predict the future price moves of an index or stock, you can still look to historical data to better understand the general trends of what occurs during a certain type of news event. With this information, you can then plan ahead to determine how to best position yourself if those trends occur.

Historical view

So how have the markets reacted surrounding past Union Budgets? The tables below show the returns over various time horizons. Over the past 10 years, the average price move on Budget Day for the NIFTY and BANK NIFTY are +0.35% and +0.94% respectively. Even going out a few more days following the budget, the average returns are also positive. For reference, the average returns for the Nifty – across all trading days for the same time period – is +0.06%. The average return across all trading days for the Bank Nifty is +0.07%. Clearly, the markets during the days surrounding the budget are more volatile than usual. In the tables, we also include the median, or most likely value, as well as the 3rd and 1st quartile of returns.

NIFTY: past 10 years (incl Interim)

1D PriorBudget Day1D Post3D Post5D Post
Average0.30%0.35%0.27%0.95%0.89%
Median0.16%-0.11%0.30%0.91%0.53%
3rd Quart1.06%0.83%0.83%2.08%2.02%
1st Quart-0.53%-0.35%-0.38%-0.39%-1.66%

BANK NIFTY: past 10 years (incl Interim)

1D PriorBudget Day1D Post3D Post5D Post
Average0.86%0.94%0.31%1.36%1.28%
Median0.67%0.21%0.38%0.95%0.95%
3rd Quart1.48%1.69%1.74%2.59%3.42%
1st Quart0.37%-0.62%-0.98%-0.45%-2.60%

While many of the returns over the last few years have been positive surrounding the budget day, they haven’t always been favourable. We also looked at what occurred on budget days in July following a presidential election for the past 20 years. In the table below, you can see that the returns on the budget day were -2.58% for the Nifty and -3.27% for the Bank Nifty. This is substantially lower than when you look across all Union Budget days. Of course, the data below only includes 4 post-election budget days and isn’t a large sample.

Last four July month budgets post-election

1D PriorBudget Day1D Post3D Post5D Post
Nifty 500.51%-2.58%-0.10%-0.96%-1.11%
Bank Nifty0.56%-3.27%-0.84%-1.14%-0.78%

Potential option strategies

Now that you understand what has happened in the past, you can use that information to develop an options trading hypothesis. Based on this past information, recent market movements, and your assumptions of how the budget will impact the macroeconomic environment, do you think the markets will be bullish or bearish in the short term? If you are uncertain of the direction and simply believe that the markets will be volatile, do you think that option strategies focused on volatility are underpriced or overpriced? Let’s walkthrough a few examples.

You are bullish on the markets

If you believe that the NIFTY or BANK NIFTY will rise throughout the budget day period, you can purchase a call option. The nearest expiry for the NIFTY50 is Thursday (25 July), and for the BANK NIFTY, it is Wednesday (24 July). Let’s look at an example call option strategy for both the NIFTY50 and BANK NIFTY.
The NIFTY closed at 24,530.90 on Friday. The at-the-money strike is 24550 and the last traded price for a call option at that strike was 217.95. The Nifty would move up by 0.97% to 24,767.95 by the expiry on Thursday in order for you to breakeven. If the NIFTY moves up by more than this, then you will be profitable.
For the BANK NIFTY, this index closed at 52,265.60 on Friday. The last traded price for a call option using the at-the-money strike of 52300 was 518.70. For you to breakeven on this option trade, the BANK NIFTY would need to rise to 52,818.70 or up 1.06% by the close on Wednesday. Any further upward moves will result in a profit.

As an options trader, if you believe that the NIFTY will rise by 0.97% or the BANK NIFTY will rise by 1.06% through their expiry dates, then these could be potential trades. The reason for the slight difference in break even points is due to different levels of implied volatility between the two indices. The implied volatility (IV) for the NIFTY call is 18.5%, while the IV for the BANK NIFTY call is 23%.

You are bearish on the markets

Let’s assume you are bearish on the major indices – you think that they will fall over the days surrounding the budget. To profit from falling markets, you can purchase a put option. The at-the-money put option on the NIFTY was priced at 217.95 as of Friday’s close. For the BANK NIFTY, the comparable put option was priced at 543.55.

Since the NIFTY closed at 24530.90 on 19 July, the Nifty would need to fall by 1.01% to 24282.05 by the Thursday expiry in order to breakeven on this trade. Similarly, the BANK NIFTY closed at 52265.60 on Friday. This index would need to be at 51656.65 on expiry, which is a decrease of 1.17%, in order to breakeven. If the BANK NIFTY is below this price point on expiry, then you will be profitable.

You believe the markets will be volatile

What if you are uncertain about the direction but believe the NIFTY or BANK NIFTY will be volatile like in past years. In this situation, you can execute a ‘straddle’. A straddle is an option strategy that involves simultaneously purchasing both a call option and a put option. You purchase these options for the same expiration date and for the same strike price. You win if the underlying index or stock moves enough to cover the costs of entering into the strategy.
While trading straddles seems like a “win-win” trade, the drawback is that you are buying two option contracts which means that you are paying the premium on two contracts rather than one. Let’s assume that you think that the NIFTY will move significantly up or down in the coming week and decide to go long a straddle on the NIFTY. The call and put prices for the 24550-strike are 223.00 and 240.10 respectively. The total cost is 463.10 (223.00 + 240.10). In order to breakeven, the NIFTY would need to move by more than +/- 463.10 from the strike of 24550 to be profitable. So, if the NIFTY’s price has moved by more than +1.97% or -1.81% on expiration, then the purchased (or long) straddle will be successful.
However, if you believe that the NIFTY won’t move this much, then you can take an opposite trade. Instead, you can execute a short straddle. Essentially, by shorting a straddle, you believe that a long straddle is currently overpriced.

Conclusion

In summary, events like the Union Budget often move the markets. With options, traders can potentially profit from any market condition whether it is up, down, or sideways. While we have presented historical data, always remember, historical returns aren’t predictive of future returns. Before starting any new trading strategy, ensure that you consider the risks and have an appropriate loss mitigation plan.


Disclaimer

Derivatives trading must be done only by traders who fully understand the risks associated with them and strictly apply risk mechanisms like stop-losses. The information is only for educational purposes. We do not recommend any particular stock, securities and strategies for trading. The stock names mentioned in this article are purely to show how to do analysis. Take your own decision before investing.

About The Author

Mike Akeroyd.jpeg
Mike Akeroyd is the VP of Product at Upstox, boasting 20 years of trading experience. An MBA from the University of North Carolina, he previously led a quantitative fund, worked in Product at Amazon and Disney, and served as an Army officer in Iraq.

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