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| Expect sharp rise in volatility |
| Devangshu Datta / New Delhi Nov 02, 2009, 00:47 IST |
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If the 4,700 level is broken, the Nifty could slide till around the 4,600 level before the next support is hit.
A downside breakout during settlement week led to a sharp increase in volatility and in trading volumes. Carryover was excellent even though the price trend was down.
Index strategies
The immediate cause of the downtrend was heavy selling by the FIIs, which also triggered a hardening of the dollar. The FIIs continue to hold around one-third of all open positions in the derivatives segment, which implies that they could switch attitude suddenly. That would make a crucial difference to the trend.
Any breakout promptly leads to a sharp rise in volatility and this one was no exception. The daily high-low range of the Nifty is likely to be around 150+ or more in the near future and this is reflected in the VIX, which is moving up.
A rising VIX is a bearish signal and there are several other signals that point to bearish sentiments. Index futures are also running at discounts to the respective underlyings. Option put-call ratios also suggest bearish sentiments.
Volumes expanded on the breakout, which is again a common phenomenon. In fact, volumes were at near-record levels through the last week. This is slightly worrying because high volumes associated with a downtrend can translate into panic. Of course, the extra liquidity would help traders to lay off risks as well. Open interest has soared in index instruments and carryover patterns have been very strong. Obviously there are plenty of people prepared to fish in troubled waters.
Although the intermediate trend may be down and traders should be prepared for net losses through November, there could well be a short-term recovery sometime in the next week or the next 10 sessions.
Any bounce could push prices up till around the 5,000-5,050 level. On the downside, there is support at the current prices and if the 4,700 level is broken, the Nifty could slide till around the 4,600 level before the next support is hit. Hence, the trader needs to be prepared for movements between 4,600-5,100 in the near-term of the next 10 sessions as well as 150+ high-low intra-day swings. The other two highly-traded index futures are very interesting in this context. Banking took a hammering last week, losing quite a bit more than the market. If there's a recovery, the Bank Nifty is likely to lead the market as a whole. So it would be a good, high-beta proxy for the Nifty, if you have a long directional bias.
The CNXIT outperformed the Nifty last week – rupee weakening may have been a factor. If there's a further slide in equity prices, triggered by further FII sales, it is likely to be accompanied by further dollar strengthening. In that event, the CNXIT will probably lose less than the Nifty. However, it is likely to move in the same direction as the Nifty itself so it is not very suitable as a counter-cyclical hedge, The Nifty option put-call ratio (PCR) is below 1 and appears to be extremely bearish because it is overbought. There is usually an inflexion point in the PCR where it drops to a point of rebound. But Friday's PCRs of around 0.9 is not really into that zone yet.
In terms of close to money spreads, both bearspreads and bullspreads have excellent risk-reward ratios. Since this is early in the settlement, further from money spreads are also worth exploring. These also have pretty good risk-reward ratios.
If you're looking for two-way positions, straddles and strangles are possible. So are positions composed of futures-options combinations. Again, the fact that it is early in the settlement gives the trader leeway to create positions further from the money.
A long 4,800c (90) and short 4,900c (57) costs 33 and pays a maximum of 67. A long 4,700p (131) and short 4,600p (92) costs 39 and pays a maximum of 61. The premium differential and the difference in returns is partially due to the fact that the Nifty is around 4,711 and the put is much closer to the money. But there may also be a component of bearish expectations built into the pricing. Further from the money, a long 4,900c versus short 5,100c (21) costs 35 and pays a maximum of 165. Similarly a long 4,600p versus short 4,400p (43) costs 49 and pays a maximum of 151.
A strangle of long 4,700c and long 4,700p (139) costs 271 and hits breakevens at 4,429 and 4,971. A straddle of long 4,600p and long 4,800c costs 182 and hits breakevens at 4,418 and 4,982 so this may be better. Again this position can be balanced off against a short strangle of short 4,300p (30) and 5,100c (21) to reduce the overall cost to 131 with a maximum return on a one-sided move of 169 and a theoretically maximum return of 469 if the market moves between 4,300-5,100 (which looks unlikely).
The simplest way of creating a two-ended position by combining a long (or short) futures with the bearspread or bullspread may be better. If the futures position is stop-lossed, the cost of the option spread plus the maximum stop-losses may be less than the comparable strangle.
STOCK FUTURES/OPTIONS
Almost all of the F&O stocks are moving down in tandem with the market. As with the Nifty itself, most major stocks are trading very close to some key support level.
The sugar sector is the only one that looks bullish as such but there could easily be bounces across the real estate and banking spaces. However, as of now, most real estate stocks look as though they have more downside. HDIL is an attractive short, for instance.
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