As Indias securities regulator ramps up scrutiny of the options market, some investors are pointing to mysterious moves in contracts tied to the nations benchmark index as evidence of questionable trading activity.Traders say one tell-tale sign of abnormal price action can be seen in the so-called straddle on the NSE Nifty 50 Index.
A hard-to-explain increase in its price during expiration days has become a common sighting in recent years, though it doesnt always happen.
It was visible as recently as mid-May.A straddle is a bet on volatility that involves buying both a bullish and bearish option on the same asset, with the same exercise level.
In a normal situation, the price of the strategy falls gradually throughout the day as the expiration approaches.Over the past two years, on several expiry days, we could see the straddle price go higher by multiples of the starting price, and sometimes not exhibit any theta decay at all for long periods of time during the session, said Devansh Gupta, managing director at New Delhi-based quantitative trading firm Algoquant, referring to the erosion of value for options as their expiration nears.
The math made no sense.
Indian markets were plunged into the global spotlight earlier this month, when the nations regulator temporarily barred Jane Street Group LLC from securities trading in an order citing index manipulation.
The US firm has denied the allegations, saying it was deploying an arbitrage strategy.Live EventsETMarkets.comThe Securities and Exchange Board of India didnt specifically mention straddles in its order, though it flagged unexplained variations in option prices.
The example it highlighted focused on weekly contracts tracking the NSE Nifty Bank Index, which were discontinued late last year as part of SEBI curbs to halt a derivatives frenzy that triggered billions of dollars in losses for retail traders.The straddle became a tool to track whether options prices on expiration days were becoming detached from the underlying asset for large stretches of time, according to about half a dozen high-speed traders that Bloomberg News spoke to before the SEBI order was released.
When the unusual pattern emerged, it likely reflected the presence of a whale making big bets in the market, they said.
The traders also noticed the abnormal trading in less liquid options on the BSE Sensex Index, among other gauges.Earlier this month, a SEBI official told Bloomberg News the regulator will expand its market-manipulation probe to include trades around other major equity gauges, including the Nifty 50 and Sensex.There may be patterns similar to those described in the July 4 order in other indexes or trading behaviors reflecting alternate strategies that have not yet been analyzed, SEBI board member Ananth Narayan wrote in the document, adding that the regulator observed some suspicious activity on the May 15 expiration day.Market activity has slowed in Indian derivatives since Jane Street was barred from trading.
On Thursday, the first major expiration day that followed the ban, the India NSE Volatility Index tracking bets for Nifty 50 swings ended at its lowest level in more than a year, and volume of options on the gauge was lower than on recent expiration days.
The total premium paid for the derivatives on the nations largest bourse tumbled to a four-month low.
That day, the strange pattern on the Nifty 50 straddle was nowhere to be seen.