Monthly expiry week trading

Monthly expiry week is a special week. Basically what happens is that people take positions in monthly stock options at the start of the month. Theta decay happens for the whole month and these contracts become near worthless in the last week and hence very cheap. This is the perfect time to turn from option writer to option buyer and play for large contra reversal gains with very small investment. So let's say a stock is technically weak, so you write CE options for the stock. The stock falls for 3 weeks, CE options becomes worthless. Now stock is oversold and it is perfect time to play for reversal by buying low value CE options.
These games make the stocks and markets very volatile in the last week of the month. Look at what happened in the last week of May expiry. BankNifty was weall and falling for most of the month. However in the last week SBI result date was announced which was expected to be good. This triggered a massive rally in BankNifty from oversold levels sending it up 4% in a single day.
Most stocks hit strong resistance levels in a single day all at once. SBI hit 400, HDFC Bank 1500, Axis Bank 740, ICICI Bank 650. These were the strikes where maximum CE was written and had huge OI built up. These positions got trapped. SBI results were better than expected from NPA point of view and couple of other news hit the exchanges like SUUTI stake sale in Axis and trasfer of reserve from RBI to government easing the fiscal pressure on the government. This triggered followup run up in banking stocks further trapping CE writers.
CE writers were forced to run for short covering, but they did not just exit in loss. Considering expiry was near these CE writers kept rolling their CE positions to next strikes hoping for some reversal. So they moved highest CE OI in SBI from 400 to 420 when SBI moved to 410 and in HDFC Bank to 1520 when it moved to 1505. Next day BankNifty opened slightly positive and these rolled up positions again got trapped and they were again forced to cover leading to massive spikes in BankNifty due to another round of short covering.
Understanding this is very important on how option writers get trapped and how it leads to ripple effect moves. If expiry was far most likely option writers would have just booked their losses and gotten out of the game or moved to a much farther strike CE. However this was not possible in expiry week because only near ATM options will have high premium value. Far strikes will be worthless and hence won't compensate for the losses in current strike. This forced the option writers to keep writing near ATM options which acted as more fuel for already trapped positions. Very small move of 10-20 points in these bank stocks would trigger short covering. Since this was happening in all the four major BankNifty components HDFC, ICICI, Axis Bank, SBI this lead to very volatile moves in BankNifty also.
An expiry week to remember!
Lessons learned
- In the last week, preferably take positions only Tuesday onward
- Avoid Monday/Tuesday
- Study individual stock option chains before taking positions
- Make sure CE and PE sides are balanced both at Index and stock level before taking positions
- If stock option chain indicates possible large moves in heavy underlyings like HDFC bank, don't deploy full cash and keep sufficient buffer from ATM