Disclaimer: Options trading is considered extremely risky, 9 out of 10 traders incur a net loss, please trade responsibly. See the SEBI circular for more details
Options premium decay as it approaches expiry and eventually all the options that are out of the money (OTM) would expire worthless. However this decay is not linear, and the premiums decay faster as they approach the expiry day, which means the decay is fastest on the expiry day. This makes expiry day special for option sellers, as 70-80% of all options generally expire worthless.
Now let us see what we can do as options traders, to use this behaviour to earn profits. The market is usually very volatile towards the expiry day, which is Thursday for NIFTY and BANKNIFTY, and Tuesdays for FINNIFTY. In a volatile market the premium of the options would increase, however, there is a strong decay in premium as well, which makes it less noticeable.
This is an IV (Implied Volatility) chart of NIFTY and the peaks that we see are the ATM IV at the end of Wednesday, if you see immediately after the peak, there is a crash, which means the volatility drops at the end of expiry.
In such a scenario, a Short Strangle or Short Straddle is usually the best option strategy, as these strategies are non-directional and benefit from increased volatility.
You should only use a Short Straddle in case you are familiar with the adjustment required in case the market moves, A Short Strangle is a relatively safer strategy that allows you to profit from a range-bound market.
200 NIFTY Short Strangle
200 Short Strangle is my personal favourite strategy to use on expiry days for NIFTY. We sell a Call option of ATM + 200 and a Put option of ATM – 200 strike. This creates a range of 400 points for NIFTY, if you are expecting NIFTY to move more than 200 points, then you can create a wider strangle of 300 or 400. I usually go wide only in case the volatility is very high, in which case I would make a similar amount of money on a 300 NIFTY strangle as a 200 NIFTY strangle.
This is a backtest of 200 NIFTY strangle on expiry day for the year 2022, and as you can see on 88% of the expires, NIFTY did not break the 400-point range. The important thing to remember is that this backtest does not have any adjustment or stop loss, so if you use proper adjustment or stop losses, then you would still be able to get out without a huge loss on the 12% of the expiration.
This 12% expires in 2022, including 24th Feb (Ukraine war) and 16th June, if you were trading on those days, you know what I am talking about.
Open Interest
One of the important things to look for before you place your strangle is the open interest chart. An open interest chart will tell you where most of the people have put their money, if a majority of people have sold PUT options, we can expect that most of the option sellers are expecting the market to go up. This would be represented in the PE open interest to be significantly higher than CE open interest.
This is an open interest chart for the 7th Sep expiry, as we can see there is a huge build-up of open PE interest on the 19300 strikes, this means that most of the option sellers are expecting NIFTY to be above 19300 at the end of the 7th Sep. Similarly, we can see two spikes of CE open interest on 19500 and 19600 strikes, this means that there could be resistance faced by NIFTY around those levels.
Conclusion
Expiry day trading is very popular with both option sellers as well as option buyers, Buyers love expiry day as the premium is very low, allowing them to increase the lot size, while sellers love expiry day as premium decay is fastest and they would make maximum gain on this day.
Whether you are a seller or a buyer, you can not ignore expiry-day trading.
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