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| Expect 600-point swings either way |
| Devangshu Datta / New Delhi Aug 03, 2009, 00:25 IST |
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The markets will either consolidate at current levels or rise till targets in the 4,900-5,000 level are hit
A very high volume settlement ended with an upwards breakout. The carryover pattern was excellent and FIIs are back in the thick of action.
Index strategies
Very high volumes were generated on the last two sessions of the July settlement and the carryover was good. FIIs increased their F&O exposure after several weeks of lying low. Their share of open interest (OI) jumped from 31 per cent (July 24) to 38 per cent last Friday.
The hedge ratio (Nifty-based positions as a ratio of all OI) has dropped, which is a sign of growing confidence on the part of bulls. However, the daily volatility of the Nifty has risen and so has the Vix, unreliable as that is.
The perspective for August seems straightforward. The market is in an intermediate uptrend and it has made a breakout immediately after the July settlement. Institutional attitude is positive. Technical signals suggest the market will either consolidate at current levels or rise till targets in the 4,900-5,000 level are hit. Disquiet about this scenario would arise only if the market dropped below 4,400 for the Nifty.
Among background signals, the rupee is getting stronger on the basis of steady FII buying, unchanged policy rates and moderate inflation expectations. Index futures are all very close to their underlying value with the CNXIT and Bank Nifty both settled at a mild premium to underlyings.
One mild danger signal is that put-call ratios are quite low. The Nifty put call ratio (PCR) (in terms of OI) for all series is around 0.97 while the PCR for September and beyond is just 0.83. However the ratio for August is at a healthier 1.3 and the low PCR could be an aberration that will correct once the new settlement really gets moving. It is also true that an unusually high 47 per cent of OI is in September and beyond but this could correct in the next couple of sessions. Futures OI is focussed on August with over 98 per cent of all Nifty futures OI in August.
The CNXIT has outperformed the Nifty for a few weeks, a pattern that is unusual when the rupee has strengthened. The Bank Nifty underperformed for a while as it became apparent that the RBI was going to sit on its hands. However, it has started to outrun the Nifty again. Given that the Bank Nifty has much more liquidity and a higher long-term beta with respect to the Nifty, it seems to be a good instrument for long traders. The CNXIT is tempting on the basis of the past few weeks but it is much less liquid and the long-term reverse correlation is a danger signal.
For what it’s worth, an examination of the December 2009 put options series shows that there is a fair amount of put OI in 4,000p and 3,700p contracts with breakevens ranging from roughly 3,500-3,900. Similarly the December 2009 call options series shows OI with breakevens in the range of 4,800-5,100. These would be the limit of expectations in the calendar year. Most traders will be directional in a trending-up market. But even short-term corrections in a market where the Nifty swings 120 points a day can lead to drops of 10 per cent. Given that this is a reasonably long settlement, the trader should stay braced for fairly large swings in both directions. I would say a swing of 15 per cent or roughly 600 points either way is possible.
The risk-return ratios for both directions are balanced close to the money. A standard bull spread with long 4,700c (143) and short 4,800c (101) costs 42 and pays a maximum of 58. A standard bear spread with long 4,600p (155) and short 4,500p (113) also costs 42 and pays a maximum of 58. With no real difference in terms of payoffs, most option traders will go up.
A two-way position with a long-short strangle combination can be set up if you prefer to hedge. A long 4,400p (82) and long 4,800c (101) could form the long strangle while a short 4,000p (19) and short 5,200c (21) would form the short strangle. The net initial cost of this position is 143. It has breakevens at 4,257 and 4,942. The maximum return at 4,000 and 5,200 is 257.
A combination of a bear spread and long Nifty future is cheaper and works better if you want a hedged position that gains more on a directional move. A short 4,500p, long 4,600p and long future (with a stop loss at 4,575) for example, costs an initial 42. The maximum loss is 78 between 4,575-4,600. On the upside, the breakeven is 4,678 with unlimited returns beyond.
On the downside, the loss declines to a minimum 3 at 4,500.
Similarly a long 4,700c and short 4,800c coupled to a short Nifty future (with a stop at 4,675 or 4,700) is possible. Here too, the downside gains are unlimited with breakeven at 4,596 and the upside loss is a maximum 81 between 4,675-4,700. Losses start declining above 4,700 with breakeven at 4,781 and a possible gain of 19 points if the market does hit 4,800.
STOCK FUTURES/ OPTIONS
One reason to expect the market to stay in an uptrend is that sector-specific trends have been broadly bullish. This makes it difficult to find stocks that may be worth shorting.
There is the likelihood that the market will turn more stock-specific as Q1 results flow in. However, safe short positions don’t seem to be obviously available.
One potentially interesting long position is India Infoline, which is picking up unusual futures volume and OI and appears to have a bullish price line.
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