In the dynamic world of the stock market, unusual occurrences can offer us valuable insights into the intricate mechanisms at play. Such an incident unfolded on the 10th of October, 2023, when the FINNIFTY index in Mumbai exhibited a classical case study of how algorithms and market dynamics can impact trading outcomes. In this article, we will delve into the events of that day and explore the underlying factors that led to this fascinating phenomenon.
Basket Buying Orders Triggered a Rally
At precisely 12:00 PM on that eventful day, a significant development took place in the Mumbai stock market. A buyer placed basket buying orders in three prominent banks: Kotak Bank, ICICI Bank, and Axis Bank. This action had an immediate and dramatic effect on the FINNIFTY and Banknifty indices. Both indices, which had been relatively quiet, began to rally.
In just ten minutes, the FINNIFTY surged from 19,688 to 19,772, while the Banknifty soared from 44,080 to 44,225. This sudden and sharp increase in these indices set the stage for a day of remarkable price movements.
Options Premiums and the Impact on CE and PE Prices
One of the striking aspects of this event was the behavior of call options (CE) and put options (PE) premiums. As the FINNIFTY was set to expire on that day, the call option premiums skyrocketed, transitioning from being relatively low to becoming multibaggers. For instance:
- The 19,700 CE option premium jumped from 21 to 155.
- The 19,750 CE option premium increased from 6 to 109.
- The 19,800 CE option premium rose from 2 to 69.
This may appear to be a natural response to a bullish market, which it is, but the peculiar aspect was the simultaneous rise in put option premiums. For instance:
- The 19,600 PE option premium increased from 2.5 to 10.75.
- The 19,550 PE option premium surged from 1.25 to 16.5.
- The 19,500 PE option premium astonishingly grew from 0.75 to 22.5.
The Curious Case of Rising PE Prices
The question that naturally arises is, “Why did the put option premiums rise when the index was going up?” This seemingly counterintuitive phenomenon can be attributed to the power of algorithms and the greediness of option sellers.
To illustrate this, let’s consider an example: An option seller had 100,000 quantities of the 19,800 CE option sold at 2 and 100,000 quantities of the 19,600 PE option sold at 2.5. This is known as a short strangle strategy, which essentially expects a range-bound expiry. The seller anticipated a profit of 4-5 lakhs from this trade.
However, when FINNIFTY experienced a sharp uptick, the seller’s stop-loss (SL) was triggered on the 19,800 CE option, leading to a significant loss on that side of the trade. In a state of panic, the seller attempted to cover the loss at a price of at least 10 or higher, resulting in a substantial loss on the CE side.
Yet, intriguingly, the seller’s algorithm automatically triggered profit booking on the PE side due to the massive upswing in the index. This triggered a buying frenzy among algorithmic systems, leading to a surge in PE orders. Consequently, many out-of-the-money (OTM) PE options experienced unexpected price movements, causing double stop-loss hits for numerous non-directional sellers.
The Role of Algorithms
This entire scenario was largely influenced by algorithmic trading. Option sellers who had been attempting to capitalize on modest premiums in the market found themselves facing substantial losses. What they expected to be a profit of 3-4 lakhs turned into a staggering loss of 30-40 lakhs.
The Changing Landscape of Option Trading
The takeaway from this intriguing market event is that the landscape of option trading is evolving. The years from 2017 to 2021 were favorable for option sellers due to high volatility (vix) and low margins. However, the situation has changed in 2023. As long as low Vix levels persist below 14, this may well be the worst environment for option sellers.
Conclusion
The events of October 10, 2023, in the Mumbai stock market, serve as a vivid reminder of the power of algorithms and the potential pitfalls of option trading. It underscores the need for traders and investors to adapt to changing market conditions and be vigilant in the face of unexpected developments. As the financial world continues to evolve, understanding the intricate dynamics at play becomes increasingly vital for success in the market.