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| Bearspreads look the safer option | | DERIVATIVES |
| Devangshu Datta / New Delhi Aug 18, 2008, 03:32 IST |
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Bearspreads in the short term, bullspreads cheaper if market falls to 4,300.
Derivative volumes stayed high despite the apparent cutting of exposure by the FIIs. The market seesawed through the first three sessions before a downside breakout. There’s still two weeks for settlement, but carryover trends look healthy.
Index strategies
The FIIs lightened their derivative positions – this is consistent with a trend that started around two weeks ago. They hold about 35 per cent of outstandings, about 5 per cent less than their usual positions. But derivative volumes remained high as Indian operators took up the slack.
There was a drop in open interest in the most popular Nifty August futures contract as over 4 lakh August Nifty were extinguished on Thursday. However, 3 lakh new September Nifty positions were opened as well. That suggests healthy carryover.
The Vix is trading around 35 after moving down early in the week. That is reasonably high and if the downtrend stays in force for two more sessions, we will see volatility spike. The VIX calculation method makes it unreliable in the last eight sessions of settlement when liquid near-month options are replaced by illiquid far month options.
Surprisingly, the downside breakout on Friday did not send index futures into discount territory. The three Nifty contracts and the CNXIT and BankNifty all settled at small premiums to the respective underlyings.
This was especially surprising in the BankNifty, which saw a massive drop of 6.5 per cent week-on-week. It was more understandable in the case of CNXIT, which outperformed the overall market on rupee weakness.
The BankNifty continues to exhibit a negative perspective since most banking majors have broken key supports. It also has a history of sudden sharp recoveries. However the WPI is now nudging 12.5 and that will take at least a couple of sessions to discount.
The CNXIT can probably be sustained at around current levels because the majors all looked strong on Thursday when the market looked weak. The rupee direction will presumably continue to have key influence. In both BankNifty and CNXIT however, individual heavyweight constituent stocks are better traders’ counters because they have far more volume than the index future and near complete correlation in terms of direction. Either TCS or Infy would be a good proxy for CNXIT while any of SBI, ICICI and Axis could mirror BankNifty effectively.
Our technical targets for next week and up until settlement (Aug 28) are intriguing because the intermediate trend is not clear though the short-term trend is clearly negative.
We could expect a downside target till around Nifty 4,300 at least on the basis of the short-term downtrend. But the upside depends on the intermediate trend direction. If the intermediate uptrend that began in mid-July is still alive, we could see an upside till 4,700 or 4,750. If the intermediate trend has reversed, the market will not be able to cross resistance at the 4,550 mark. Intra-day volatility is likely to stay high.
The Nifty put-call ratios confirm short-term bearishness. The August PCR (in terms of OI) has dropped to just below 1 and that is bearish. The overall PCR is at 1.1 which is also on the bearish side. There has been reasonably good carryover with about 38 per cent of OI in contracts that are September and beyond.
In terms of long-term perspective, the key December 2008 5,000c (132) and Dec 2008 5,000p (690) hold quite a bit of OI. The respective breakevens are around 4,300-5,130 and these could be considered “consensus estimates” for long-term hedgers.
There is still room for wide spreads since there are nine sessions to go and four before the full margin is applied. The standard bullspread with long 4,500c (80.65) and short 4,700c (24.3) would cost 56 and pays a maximum of 144. The standard bearspread with a long 4,400p (94.15) and short 4,200p (36.85) costs 57 and pays 143. The bearspread is closer to the money.
However while these ratios are ok, the chances are neither of these positions will be fully realised without either a big bounce or crash. Therefore, narrower spreads such as long 4,500c and short 4,600c (46) and long 4,400p and short 4,300p (60.95) are safer. The narrow bullspread costs 34 and pays 66 and the bearspread costs 33 and pays 67. Not much of a difference at all!
The bearspread looks more likely to gain in the very short-term and if the market does fall to 4,300, the bullspreads will be available more cheaply. Especially so, since the expiry factor will also come into play and reduce all August premiums.
So, one possibility is to take a bearspread and wait until the market falls before taking a bullspread. Another possibility is to take a narrow bearspread (long 4,400p-short 4,300p) and couple it to a far from money call such as long 4,600c. This position would work if the intermediate uptrend does remain in force after a short-term downtrend. Even if the 4,600c is not struck, its premium value may rise if the market swings back over 4,500.
STOCK FUTURES/OPTIONS
Practically the entire F&O segment went into a downtrend on Friday. As mentioned above, long in IT majors or short in bank majors is worth considering.
Another play is long Reliance Industries, based on the possibility that crude prices will continue to ease. A long RIL should have a stop at 2,250 and a target of 2,375. A contrarian may try a long Tata Steel since the stock has found support between 600-615. Keep a stop at 600 if you go long in Tata Steel and exit at a target of 645.
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