“That was a total dick move” — Someone at SGX
First things first. None of this might go through because SEBI has allowed this does not mean NSE or BSE will implement it. But, having said that, there is a very high chance of this going through given the recent SGX developments.
Before we get into the option math of what would happen, let us look at simple things on a lighter note.
- Option traders- Poor guys had a life after 3:30, now they do not. Which also means Bombay is the only city to trade now, given the party starts after midnight there. The only place which remains open after 11:55 in Bangalore is the chaiwala on the cycle in Madiwala Junction.
- Interesting life for Retail F&O junta — These guys worked day jobs, and occasionally sneaked out and traded during office hours. But now they will go home and trade. I am worried for their wives and girlfriends.
- Less gambling now — If you take a position when a US event such as FOMC, or NFP, or US GDP is going to come in the evening, you are gambling. Now we will see less of that. In short, around 11:55 is a good time to place your bets. And it’s more predictable, and less of a gamble.
- Hours of volume will shift — In long hour markets such as FX, most of the volume happens during London Open, US Open, and London close. We could potentially see such a shift. If you do not like the mornings, hurrah!
- NRI Community can now trade F&O. The more participants the merrier, right?
- All those TV channels which give gyaan about markets — they will double their ad revenues now.
Okay, so what will happen to the market?
- The number of violent gap up and gap down openings will come down.
- Implied volatilities on stocks and indices will go down.
The number of gap up and gap down openings will go down simply because the nasty overnight surprises coming from overseas, especially the US, are not overnight surprises anymore.
- Most data releases in the US happens around 6:30 India Time. Now they will happen during India hours. Even the late ones such as FOMC which happen at 11:30 IST will give 15 minutes for India to react. The only exception is Daylight Saving Time adjustment (DST) from November to March. DST sets clocks in the US back by 1 hour. So we will miss a few events which happen at 12:30 in the night IST during DST adjustment months. Let’s ignore that.
- A lot of US markets action will now happen during India hours, which means we will react while the US is reacting, which leads to a continuous adjustment rather than gap jumps.
- We will now trade during London and EU closing hours, which takes care of most of the European markets and certain other asset classes such as FX and commodities.
Okay, so how does implied volatility on every single stock and index out there come down?
Implied volatility is a measure of uncertainty in the market. It says how unpredictable the option sellers think the markets are. The biggest uncertainty an option seller faces is the overnight gap risk. The daytime volatility is something which traders can easily manage. If there are no gaps, it is much easier for traders to sell options and manage their risks. So a large part of Implied Volatility is about the gaps will on opening. With less and smaller gaps there is lower uncertainty.
Thus, the implied volatility will fall.
What about the effect on market participants?
Good for institutions who sell options with continuous delta hedging. Now they have a better shot at continuity of hedging. Continuous delta hedging needs VERY large positions. So we are talking about the large institutions.
Bad for option sellers who sell without continuous delta hedging, because the IV, and hence the absolute premium on options is now lower. Smaller players and retailers will be worse-off
Silver lining for retailers- Option buying will be a better game if IVs will fall. I think it will still be a bad game. It will become a less loss-making game from a massive loss-making game.
In the next post we will see why IV will drop if there are no gap openings. Here is where the fun starts. Read that only if you like hardcore stuff. Here is the link to Part 2