Hedge Nifty using Modified Put Butterfly strategy: Shubham Agarwal

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As they say, all’s well that ends well. Last week started on a rather nervous note for Nifty with no signs of a comeback till mid-week. However, the moves we saw in the last two trades of the week were strong enough to erase the early losses and on top of it put a percent gain on the charts on a weekly basis for Nifty. However, the drop piercing into the lows of the previous week did shake the confidence of many it seems.

Bank Nifty too had a rough start. In fact, the drops were worse than that of Nifty comparing the respective previous week lows. The recovery was seen, however, in Bank Nifty towards the weekend. The recovery proved too little though. Almost 3 percent move in the last two trades could not undo the damage created early on pushing Bank Nifty down by almost a couple of percent for the week.

Open Interest (OI) activity in the index futures was quite different as well. Nifty futures saw drop in OI in the first 3 sessions of last week. This can be attributed to the unwinding of previous longs. The following sessions could attract fresh longs. However, unlike the price, OI could not undo the loss. We ended the week with a drop in OI for Nifty attributed to long unwinding to the tune of 7 percemt.

Bank Nifty added fresh shorts in the first session. The following 4 sessions of the week saw withdrawal of interest only. While in first two we had drop in OI attributed to unwinding of previous longs, in the last two sessions we saw short covering.

On the stock futures front, on the whole, there was a reduction in OI. Almost half of the major sectors lost OI. The OI activity also among the stock futures was divided equally among Long, Long Unwinding, Short and Short Covering stocks.

Slicing the stock futures data further, many sectors this week did not see aggregate change in Price or OI over 2 percent. Auto had unwinding of shorts led by 2-wheeler stocks, while Oil stocks except IOC and BPCL had unwinding across the sector. PSU Banks saw unwinding of bargain hunting longs with exception of shorts in Bank Of Baroda, similar long unwinding was seen in Telecom led by Idea.

Coming down to sentiments, the risk index India VIX remains on a rather confident mode. The implied volatility of Nifty is now comparable to the pre-pandemic levels. This kind of complacency is a little scary considering the changing landscape of the world economy.

Similar to this is the Options OI composition which is summarized by OIPCR. OIPCR is also sending over-optimistic signals considering the Nifty levels it could be termed apt but still having OIPCR at the highest level since the pandemic hit is a bit scary.

Finally, Nifty futures lost OI to net long unwinding in a rising week. Sentimental indicators like India VIX and OIPCR are at the optimistic end. Overall response in terms of long interest in the futures segment lacks similar aggression. Over optimistic sentiments along with lack of confidence among futures participants advocates a hedge in Nifty hence Weekly Modified Put Butterfly is advised.

Modified Put Butterfly is a 4-legged strategy where 1 lot of Put close to current underlying level is bought against that 2 lots of lower strike Puts are sold and 1 more lot of Put is bought but closer to the Put sold strike. This keeps the lower but constant profits in case of downward breakout. This is a fairly risk averse and a universal strategy.

The author is CEO & Head of Research at Quantsapp.

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