Impact of market volatility on Options Trading
Impact of Market volatility on Options trading:
What is Market volatility:
Volatility refers to the degree of fluctuation in the price of a stock or an instrument over a specific time period. It can be the fluctuations that has already happened or expected in the future time periods. Generally, the term volatility is associated with uncertainty and a sense of fear among the market participants. While it can be used to one’s advantage if predicted correctly, it is more of a double-edged sword that one should be careful of.
The picture above perfectly encapsulates what a volatile market would like. The benchmark Indian market index, Nifty rose 800 points, fell 1000 points, recovered 1000 points, and again fell 1000 points - all within a time frame of 20 days. The reason for this volatility is the ongoing parliamentary elections and the results of the same which is around the corner. Irrespective of the reason, this level of volatility creates a huge uncertainty.
Impact of market volatility on options trading:
While volatility to a certain extent may be favourable for option buyers, it is the last thing an option seller would wish for. Highly volatile market makes it extremely difficult for option traders to take a position due to the uncertainty of the further moves. Let’s take 15th May of 2024 as an example to check how different strategies would hold up in the markets amid election volatility. On 15th may nifty opened in a gap up of 120 points and went on to fall 200 points in the initial two hours and regained 200 points within an hour! Post 12.20 PM there was a strong bearish sentiment during which nifty fell 300 points. If you were to ride the trend and went long on 5 lot of put options around 1.00 PM planning to take advantage of this strong bearish sentiment, your stop loss would’ve been triggered in just about 60 minutes and nifty would go on to gain around 300 points from your entry position in just an hour. This would be the perfect example to demonstrate what a volatile market would look like.
This is the backtested result of the above stated 5 lots of PE buy transaction, which shows ₹2000 loss. It was done on Quantman, an algo trading platform which enables options trader to elevate their trades through the backtesting feature and impeccable live execution. The backtesting feature provides a range of parameters using which traders can analyse and enhance their strategies.