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| Advantage near-the-money spreads | | DERIVATIVES |
| Devangshu Datta / New Delhi Jul 28, 2008, 03:43 IST |
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For Nifty futures, keep stops at 2-3 per cent off the transaction price.
It’s been an eventful week, given the confidence vote followed by the blasts in Bangalore. There has been massive daily volatility and sentiment has weakened noticeably despite the overall gains. The settlement promises to be exciting with very high volumes and very high intra-day volatility.
Index strategies
Last week was consistently high-volume on the derivatives front and indeed, much higher than seen in the past several months. There’s been an excellent carryover pattern so far. About 25 per cent of Nifty futures is already in mid+far month contracts and above 38 per cent of option open interest is also parked in contracts beyond July.
The FIIs have been enthusiastic participants and their position mix suggests that they are optimistic. About 38 per cent of their outstanding positions are in index options – this number is higher than normal as it often is when the FII change cash market perspective alters. They have been net buyers for the past week after being net sellers through most of the past three months.
If the high carryover pattern is maintained, the last four sessions of this long settlement will see huge volumes. At the same time, daily volatility has spiked alarmingly and the VIX has risen to above 40. This is way above the danger-mark. The fear factor is clearly evident. High volumes and high volatility adds up to a very heady combination, which could take the market through a zigzag.
The put-call ratios are bullish. The overall PCR (in terms of OI) is at 1.37 and falling while the July PCR is 1.31. Interestingly we also have a large imbalance in OI sitting in winning option positions. About 2.6 per cent of Call OI is in-the-money while over 9 per cent of Put OI is in-the-money.
This suggests that there are more bears around at this instant and the market is oversold. It implies that there will be short covering on Wednesday and Thursday, provided the market doesn’t free fall early in the week.
Most index futures are running at slight premium to the spot index. There’s higher than normal liquidity in the Bank Nifty and the CNXIT, where’s there’s already evidence of carryover. Both the Bank Nifty and CNXIT look weak and a short-covering trend should be visible by Wednesday.
Technically there is support for the Nifty at current levels and immediately below. The chart support is reinforced by the appearance of the option chain, where there’s a lot of OI in the 4200p and 4300p. If 4200 is broken, the market is likely to fall below 4100 however. On the upside there’s resistance all the way till 4600. The call option chain suggests that successive levels of 4400, 4500 and 4600 will all be major barriers.
The trader could expect that the market will swing about 150-200 Nifty points per day and that the settlement week could see a trading range between 4100-4600. That’s a huge range and it makes the strategy of July option selling to take advantage of the expiry factor quite dangerous.
The good part of this promise of high volatility is that close-to-money spreads in both directions could gain even within the same session. You don’t need to take a tight directional view if you have the courage to hold an apparently losing position. If you employ Nifty futures, keep stops at about 2-3 per cent off the transaction price.
A standard bullspread with long July 4400c (42) versus short July 4500c (19.45) costs 23 and pays a maximum of 77. An August position with long 4400c (153.65) and short 4500c (108.8) costs 45 and pays a maximum of 55.
A standard bearspread with long July 4300p (59) and short 4200p (29) costs 30 and pays a maximum of 70. An August bearspread with a long 4300p (170.75) and a short 4200p (135.55) costs about 35 and pays a maximum of 65.
The July holdings offer excellent risk:reward ratios and as mentioned above, both of these could be struck despite the expiry factor. All it would take is a 3 per cent swing down or a 5 per cent swing up. If you decide to carryover by opening August option positions, the risk:reward ratios remain decent given the extra 4 weeks of time to expiry.
If you decide to go for strangles, August is the better contract month to avoid risk of expiry. In that case, go wider with a long 4200p and a long 4400c. The long strangle costs 289 and it should be cut off with a short 4000p (86.15) and a short 4600c (78.3).
That combined long-short strangle position has a cost of about 125 and if the market swings to either limit (4000, 4600) by August 28, the maximum return is 75. If the market swings to both limits, the payoff is 150.
STOCK FUTURES/OPTIONS
Last week, it made sense to concentrate on the extra liquidity and hedging possibilities offered by the Nifty options. This week, stocks are more likely to offer strong moves that have trends independent of the market.
If you stick with the index heavyweights such as RIL or the ADAG scrips like Reliance Capital and Reliance Infra, you will get amplified high-beta versions of the Nifty’s moves. But stocks like Hind Unilever, PGCIL and Renuka may well remain bullish regardless of the overall market trend.
Renuka looks especially interesting since the stock has developed very high OI along with a bullish price line. Go long in a July future with a stop at 117 and a primary target of 135.
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