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| Bearish expectations till July | |
| Devangshu Datta / New Delhi June 29, 2009, 0:35 IST | |
The bearspreads look better on a directional basis as well in terms of risk-reward ratios.
The July settlement opened on Thursday with very low carryover and muted sentiment. Matters improved marginally on Friday but it looks as though July will see net losses.
Index strategies
The loss of volumes is very marked and the clearest signal of a trend reversal. The last three settlements have generally seen derivatives volumes in the range of Rs 65,000-Rs 70,000 crore traded daily. Each one has excellent carryover with more new positions being opened in the last four sessions of the settlement than are extinguished.
That’s changed in the past 10 sessions or so. Daily F&O trading volumes have dropped to around Rs 40,000-Rs 50,000 crore and overnight positions have been drastically reduced. The July settlement currently has about 35-40 per cent less open interest than one would consider normal.
The market came off some 10-12 per cent from its peak before it made a recovery on Friday. Volumes also thinned in the cash segment as well as in derivatives. Premiums in the July settlement are quite high, suggesting nervousness though the effect is somewhat masked by the VIX calculation methodology.
FII derivative exposures remain steady in absolute terms but these have grown in percentage terms as far as total open interest (OI) is concerned. Since the foreigners are on a selling spree in equities, it is interesting to examine the composition of their derivative positions. About 59 per cent of FII outstandings are in index instruments. This is a low hedge ratio that suggests a fair amount of the FII derivative action is speculative with a focus on single-stock instruments.
The easing of volumes is very marked in the benchmark Nifty futures contract, where OI has fallen 29 per cent compared to last Friday. Almost 99 per cent of the futures volume is in July itself. Even though it's early into the settlement, this ratio is rather high. OI has also fallen in the CNXIT and Bank Nifty contracts. However, both these indices have outperformed the Nifty itself and that could mean more volume flowing into them if the overall trend gets worse.
This could happen because, technically speaking, this smells like the early stages of an intermediate correction. Prices have recovered from their lows on thin volumes. If the correction continues, the market is very likely to bottom out in the 3,800-3,900 range, where the first Fibonacci retracement level lies. If the Budget is not market friendly, it could drop further.
A look at the put-call ratios and the composition of Nifty option positions suggests that the market is quite bearish in its sentiment. The Nifty PCR in terms of OI is around 0.94 overall and it is about 1.1 in the July settlement with a very bearish 0.8 PCR in August and beyond. Furthermore, as much as 45 per cent of option OI is in August and beyond, it makes the bearish signal stronger.
For what it is worth, the December 2009 3,700 put and the December 2009 3,800c and December 2009 3,600c have large OI. Adjusting for premiums, breakevens are in the range of 4,600-4,700 for the calls and at 3,450-3,500 for the puts. That would be the approximate limit of optimistic and pessimistic expectations in the next six months.
In the context of the next 10 sessions, the Budget is sufficient cause for ample caution because Budgets usually trigger higher than normal volatility. As things stand, the Nifty has been swinging about 150 points per session. It would be reasonable to expect at least some 200 point sessions in the next fortnight. Option premiums in the July series are higher than normal. They may drop slightly in the next week as the option chain gets populated but they are likely to remain on the higher side. In the circumstances, option-selling remains a tempting but highly dangerous game. If you wish to sell, gambling on historical volatility being lower than implied volatility, stay at least 200 points away from the money.
Close to the money, risk-reward ratios are almost balanced. A bullspread with long 4,400c (186) and short 4,500c (140) costs 46 and pays 54. A bearspread with long 4,300p (155) and short 4,200p (118) costs 37 and pays a maximum of 63. The bullspread is practically on the money with the futures having settled at 4,385. A bullspread of long 4,500c and short 4,600c (103) costs 37 and pays a maximum 63. The bearspreads look better on a directional basis as well in terms of risk-reward ratios.
Long strangles can be created with say, a long 4,200p and a long 4,600c–this costs 221. The net cost can be reduced to 107 by selling a short strangle of short 4,000p (64) and short 4,800c (50). The resulting long-short strangle combination pays a maximum of 93 with breakevens at 4,093 and 4,707. This is not very attractive though it could work if the Budget triggers a swing. Wider long-strangle positions would be cheaper but the breakevens would be correspondingly further from the money.
STOCK FUTURES/ OPTIONS
The usual suspects are generating most of the stock futures and options volume. There are potential long positions in JP Associates, Tata Steel, Suzlon, ONGC and Cairn. The entire sugar sector looks as though it may take off and Renuka perhaps has the most attractive futures position in terms of liquidity. Apart from the Bank Nifty itself, Kotak Mahindra could generate a good long position.
There are also potential short positions in RNRL, BPCL and ITC. Reliance Industries is interestingly poised–the stock could move either way. One interesting try is an option bullspread in IFCI, where there is the usual speculative action. A long 60 call (5) and a short 70C (2.3) costs 2.75 and pays a maximum of 7.25.
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