Beware from "hunter Algos"

Emergence of Hunter Algos

  • The emergence of hunter algos has made life difficult for amateur option sellers who were accustomed to making small profits on expiry days by writing out-of-the-money (OTM) options.

  • Instances of sudden brief swings in the prices of OTM weekly equity index options on both the NSE and BSE have increased over the last three months, triggering stop-losses of many option sellers.

  • Stop-loss hunting is a strategy typically used by large institutions or algorithmic traders, involving driving prices to certain levels that trigger stop-loss orders, resulting in a surge of buying or selling activity.

  • There is a growing view among derivatives traders that the recent price swings in OTM options could be due to the increasing use of stop-loss hunting algos by some players.

  • Many option sellers across different indices have experienced their stop-losses getting triggered, even without noticeable changes in the price of the underlying index, posing challenges for traders.

My sense is that it would be hard for the institution to do so

  1. Retail position is usually distributed across instruments and strikes and not concentrated like an institutional position. So targeting a specific retail position may not yield a meaningful reward.

  2. The institution has to first push up the price to individual retail stop. If this is a fairly liquid contract that would need significant amount money. Then they are hoping that the retail would exit at stop creating a push up of prices. Triple risk exist here -

    —> Retail may not exit at stop as several studies have shown (one reason why most of them 
       are at a loss)
    —> Another institution may actually sell the same strike.
    —> There may not be enough liquidity for the institution to exit even when they are profitable 
       dues to slippages.

To my knowledge institutions do not take that kind of risk. They are more into low risk low draw down strategies.

@iamshrimohan your thoughts here would be much appreciated as you have been at an institutional trading desk in the past.

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@t7support Apologies for the delayed response, ill surely reply on this in a while.

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@t7support @Saurabh Institutions typically fall into two categories: Risk Averse and Risk Taking. (An institution may embody both types together)

Risk averse institutions strictly adhere to rule-based trading practices. They avoid unhedged or risky positions (regardless of any insider information available). The RMS promptly intervenes in such cases, blocking the desk and liquidating all positions at prevailing prices if any rules are breached. Trades primarily follow VWAP and TWAP methodologies, prohibiting aggressive buying or selling. Additionally, exceeding 25% of the traded volume demands a comprehensive explanation. When the RMS takes control of the terminal in a prop desk, a red border appears on the screen, indicating the activation of Risk Reduction (RR) mode.

Risk-taking institutions engage in calculated risks, often employing strategies that could trigger stop-losses (SL). However, these strategies are supported by underlying factors, ensuring movement in the market (such as substantial buy orders in index components). Consequently, they profit significantly from buying options. Although theoretically possible, this approach requires optimal conditions, including considerations like put-call parity. Controlling an option’s price necessitates managing the reverse option’s price, a task typically undertaken by a cartel rather than a single institution. Hence, such practices are less common in options trading. Nevertheless, some brokers have attempted this using clients’ funds and holdings, ultimately leading to catastrophic losses when faced with repercussions.

Thanks @iamshrimohan. Appreciate u r insight.

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