Short term profit booking seen in Nifty, deploy traditional Covered Put strategy

Considering the overall structure, it's prudent to adopt the strategy which could capture the expected mild fall and can provide a return in the sideways market as well.

Strategy setup

The ongoing upmove in Nifty50 seems to have abated for the time being as bulls are losing grip at higher levels. The Bearish Engulfing pattern on the weekly chart indicates that bulls are likely to take a pause and short term profit booking can be expected in the index. The momentum indicators have started trading in a sideways zone and the prices are trading below rising trend line support that has originated from the low formed in the month of March. The trendline has been acting as a cushion for the index since then but it was broken on September 4, indicating that the short term trend has disturbed. In current trading week, traders can expect a mild dip in the prices till its 50-day exponential moving average which is placed at 11,131 approximately. To trade the setup, traders can deploy a traditional "Covered Put" strategy where short positions in the Nifty can be initiated along with short positions in out of the money (OTM) Put option in the ratio of 1:1. The short Put in the strategy would ensure that traders can get the premium amount in the form of theta decay as the limited and gradual fall is expected in the index.

Option chain analysis

As per the current close of 11,440.05, at the money (ATM) strike price is 11,450. The ATM Call option holds a cumulative open interest of around 11,730 contracts while the ATM Put option holds the cumulative open interest of approximately 10,400 contracts. There is no major clue emerging from ATM strike price Call and Put option but the immediate higher and lower strike price suggesting that profit booking can be expected in the index. The Call option of 11,500 strike price holds a maximum total interest of 35,980 contracts with the fresh open interest addition of more than 4,644 contracts while the immediate lower Put option of 11,400 strike price holds the total open interest of 29,846 contracts. The data indicates that bulls are cautious and mild profit booking can be seen in the coming days. The short term support is shaping up at 11,200 level as the Put option of the same strike price holds the second-highest cumulative open interest of around 27,500 contracts after 11,400 PE strike price.

Technical structure

The short term trend seems to be disturbed and profit booking can be expected in the Nifty50 in the coming days. The prices have broken below a 20-day simple moving average decisively for the first time after May 27, 2020 and RSI has shifted to the sideways zone from the bullish zone. The 'Bearish Engulfing' pattern on the weekly chart indicates that any bounce back is likely to face supply pressure in the coming days. Gap up opening on latest Monday's trading session could not sustain at higher level and closed mildly in red, indicating the profit booking at higher levels. As per the Fibonacci theory, the weekly resistance is shaping up at 11,655 which is a 61.8 percent projected retracement level based on the previous week range. On the other hand, 11,271 and 11,131 are likely to act as support for the next week.

Trading strategy

Considering the overall structure, it's prudent to adopt the strategy which could capture the expected mild fall and can provide a return in the sideways market as well. Traders can deploy a "Covered Put" strategy where a short position in the future would capture the profit booking move and short put will help in gaining premium through theta decay. For the short Put we have chosen a strike price below the first support level of 11,271.

Sell Nifty future @ 11451.95
Sell Nifty 11,250 PE @ 24.60

Expected profit – 226.55 points (subject to theta decay)

Though the deeper correction till 11,131 is also expected but the strategy would provide a uniform return of 226.55 points below the 11,250 level. Traders can keep the stop loss of 11,655 in futures which would cap the maximum risk to 178.45 points only.

Note - Option premium mentioned resembles the last traded price as on September 14 for the September 17 contract.

(The author is Head - Derivatives at Rudra Shares & Stock Brokers Ltd.)

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