Budget day is one of the most sought after event in the Indian capital markets. The reason is simple as it effects the common man of India. There is a lot of speculation that goes before the event and generally the markets are quite volatile during the whole day.
Last year, Nifty surged almost 5% after the Budget announcement. Although, the budget announcements does affect the Indian markets in the long term. We, as traders should always look for opportunities to take short term calculated risks in the market.
These calculated risks/trades can come with conviction packed in, if it is backed by historical data. In this post, we will have a look at how the markets performed in the last 8 years during the budget day and what strategy can we use to take this calculated trade.
Let’s first calculate the range in which the markets moved during the budget day.
|Year||Open||High||Low||Close||Range = (High – Low)/Open|
As we can see from the historical data that on average the market has a range of 2.91% on budget day. But, if we calculate the range based on the closing price during the budget day we can see that on average the market closes at an absolute value (can be positive or negative) of 1.35% from its open price of the day.
In the last 8 years, for almost 4 times Nifty has closed less than 1% from its open. Thus, we can conclude that the markets are really volatile during the budget day but most often the closing of the day is not much higher than the open of the day.
How to Trade?
Since the volatility is higher before the budget announcement, most options are heavily priced. Volatility cools off after the budget announcement and thus we can expect these option prices to come down. This means an ATM straddle should work wonderfully on such event days.
Not only the volatility cools off but also the theta decay eats the premium and thus selling options seems to be a lucrative strategy on the budget day. Lets analyze how an ATM straddle with proper risk management rules might have performed in these past 8 years.
Lets summarize the rules once:
- Entry: Short ATM Call and Put options at 09:20 AM
- Stoploss: Exit both legs when the combined premium increases by 40 points
- Exit: Exit the ATM Straddle at 03:15 PM
Let’s have a look at the results now.
|Year||Strategy PNL (pts)|
So, as you can see, ATM Short Straddle strategy has worked really well from 2014 to 2018 but has failed to give any profits in the last 3 years. We also tried backtesting ATM Long straddle, but due to volatility crush, it did not give any positive returns as expected.
No one can predict what will happen in the markets, how volatile will the markets be on the Budget day. The only thing that you can control is your risk. Never trade with the money that you cannot afford to lose and make sure that whatever strategy that you trade has a strict stop loss to preserve your capital if the trade goes south.
The markets will always have new opportunities that you can take advantage of, the only thing required is the discipline to trade with a risk first approach.
Until next time!