Abstract
This research analyzes derivative strategies that have been applied on the Nifty IT index, which is one of the sectoral indexes under Nifty. It involves the application of derivative strategies on five years of historical data of the Nifty IT index and determines their profitability. Two strategies have been used for this purpose: long straddle and short straddle. The success rates of the two neutral option strategies have been computed. The research aims to identify the strategy that can be consistently applied on the Nifty IT index in the future to generate profits. Payoff graphs for the most recent months have also been generated to complement the findings of this analysis. The results suggest that the success percentage of a long straddle strategy has been around 40% and that of short straddle around 60%. The authors conclude that the market is more bearish on volatility for the Nifty IT index. The short straddle strategy was more successful than the long straddle strategy for the period studied. Therefore, of the two strategies, the short straddle seems to offer the best prospects for neutral trading on the Nifty IT index in the future.
The Nifty IT Index is one of the sectoral indices under the Nifty Sectoral Index Series. The index represents the performance of information technology (IT) companies in India. It is composed of 10 IT companies that are listed on the National Stock Exchange (NSE) of India, as shown in Exhibit 1.
Nifty IT Index Companies
This study involves the application of long straddle and short straddle option strategies on the Nifty IT Index. The objective of this research is to determine the neutral derivative strategy that can generate profitability when applied on said index. The percentage success of the two neutral strategies when applied on historical data of the past five years has been determined. The analysis also involves generating payoff graphs for the most recent months to complement the findings.
The data for the analysis include historical prices of the Nifty IT Index taken from January 2012 to June 2017. The premiums of at-the-money (ATM) call and put options for specified strike prices and option expiry dates have also been used.
NEUTRAL OPTION STRATEGIES
Neutral options strategies are used when the options trader is not sure of the movement in the index—whether the underlying index price will rise or fall. The neutral option strategies can be either bullish or bearish on volatility.
Neutral strategies that are bullish on volatility are those in which profit is attained when the underlying stock price experiences large fluctuations upward or downward (e.g., long straddle), whereas profit in neutral trading strategies that are bearish on volatility occurs when the index price experiences very little fluctuation (e.g., short straddle).
Long Straddle
The long straddle involves the simultaneous buying of a put and a call option on an underlying index with the same strike price and option maturity date. In this analysis, the strategy has been constructed by buying one ATM call and one ATM put option. This strategy offers limited risk and unlimited profit, as shown in Exhibit 2.
Long Straddle Strategy Profit/Loss vs. Stock Price
Short Straddle
Short Straddle is another neutral options strategy in which a call and a put option with same strike price and maturity date are simultaneously sold on the index. Short straddle strategies offer limited profit but have unlimited risk as shown in the graph (Exhibit 3).
Short Straddle Strategy Profit/Loss vs. Stock Price
From the historical data fetched from the NSE records, the last Thursday of the month has been identified as the maturity date of the option. If the last Thursday of the month is a public holiday, the previous day has been taken as the option expiry date. The opening price of the Nifty IT Index on the day following the expiry of options has been noted. This opening price has been used as the current index price (S) for every monthly option period in the five years. This price has also been used to determine the strike price (K) of the calls and puts because these are ATM options. This is followed by retrieving the premium values for the previously computed ATM strike prices for call and put options from NSE’s website.
Calculations for Long Straddle
Profit occurs when the index price rises above or falls below a certain level. This price level is calculated as follows:
After this, the required percentage change from the current price of the index for the respective monthly period is calculated as follows:
This is followed by the calculation of the percentage change in the Nifty IT Index that actually occurred for the option periods in the historical data. This is calculated by using the open price at the start of the option period and the close price at the end of the monthly option period. Then it is determined whether the actual percentage in Nifty IT is above or below the required percentage level for the long straddle strategy to be a success.
Calculations for Short Straddle Analysis
Profit occurs when the price of the index remains within certain limits. Beyond these levels, loss occurs. These price levels are calculated in the following manner in the case of a short straddle strategy:
After this, the required percentage change from the current price of the index for the respective monthly period is calculated as follows:
The percentage change in the Nifty IT Index that actually occurred for the option periods in the historical data is then used to determine the success rate for the short straddle strategy.
The payoff graphs for the most recent months have also been generated.
PERCENTAGE CHANGE IN NIFTY IT DURING FIVE YEARS (2012–2017)
Exhibit 4 displays data for percentage change in Nifty during a five-year period.
Percentage Change in Nifty IT during Five Years (2012–2017)
LONG STRADDLE ANALYSIS
Exhibits 5 to 10 provide data on the long straddle analysis for the years 2012 to 2017, respectively.
Long Straddle Analysis, Year 2012
Long Straddle Analysis, Year 2013
Long Straddle Analysis, Year 2014
Long Straddle Analysis, Year 2015
Long Straddle Analysis, Year 2015
Long Straddle Analysis, Year 2016
Long Straddle Analysis, Year 2017
SHORT STRADDLE ANALYSIS
Exhibits 11 to 16 provide data on the short straddle analysis for the same period.
Short Straddle Analysis, Year 2012
Short Straddle Analysis, Year 2013
Short Straddle Analysis, Year 2014
Short Straddle Analysis, Year 2014
Short Straddle Analysis, Year 2015
Short Straddle Analysis, Year 2016
Short Straddle Analysis, Year 2017
PAYOFF GRAPHS FOR LONG STRADDLE FOR MOST RECENT MONTHS FROM JANUARY 2017 TO JUNE 2017
Payoff graphs for the period of January to June 2017 are given in Exhibits 17 to 22.
Payoff Graph, June 2017
Payoff Graph, May 2017
Payoff Graph, April 2017
Payoff Graph, March 2017
Payoff Graph, February 2017
Payoff Graph, January 2017
LONG STRADDLE PERCENTAGE SUCCESS OVER A PERIOD OF FIVE YEARS
The option periods for which the strategy has been a success have been highlighted in Exhibit 23.
Long Straddle Percentage Success
SHORT STRADDLE PERCENTAGE SUCCESS OVER A PERIOD OF FIVE YEARS
Exhibit 24 highlights the option periods for which the strategy has been a success.
Short Straddle Percentage Success
CONCLUSION
In this research analysis, derivative strategies have been applied on five years of Nifty IT Index historical data. Two neutral strategies, namely long straddle and short straddle, have been analyzed by determining the magnitude and direction of volatility in the Nifty IT Index.
The research determines which of these two option strategies can be consistently applied on the Nifty IT Index in the future to generate profits. Furthermore, payoff graphs for the most recent months have been generated.
According to this analysis, the percentage success of the long straddle strategy has come out to be approximately 40% and that of short straddle has come out to be approximately 60%. The success percentage of the short straddle strategy is greater than that of the long straddle strategy for the period that has been used to conduct the study. This implies that volatility in the index shows less bullish than bearish behavior. Therefore, out of the two strategies, the short straddle strategy can be followed for the Nifty IT Index in the future.
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In this issue
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- Article
- Abstract
- NEUTRAL OPTION STRATEGIES
- PERCENTAGE CHANGE IN NIFTY IT DURING FIVE YEARS (2012–2017)
- LONG STRADDLE ANALYSIS
- SHORT STRADDLE ANALYSIS
- PAYOFF GRAPHS FOR LONG STRADDLE FOR MOST RECENT MONTHS FROM JANUARY 2017 TO JUNE 2017
- LONG STRADDLE PERCENTAGE SUCCESS OVER A PERIOD OF FIVE YEARS
- SHORT STRADDLE PERCENTAGE SUCCESS OVER A PERIOD OF FIVE YEARS
- CONCLUSION
- Info & Metrics
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