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| Expect volatility to be high |
| Devangshu Datta / New Delhi Mar 23, 2009, 00:00 IST |
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Amid a possible downtrend, stay braced for a movement in either direction.
High carryover and profit-booking may characterise the last week of the March settlement. Volatility is likely to rise, going into the next two months.
Index strategies
The high carryover is being triggered by election considerations. As of now, the April-May Nifty futures open interest (OI) is about 35 per cent of all index futures OI. There is also higher than usual carryover evident in the CNXIT and BankNifty. Around 45 per cent of the Nifty option OI is also in April and beyond, but that ratio is closer to normal.
The rising prices of the past fortnight have reflected a global trend of technical recovery but, India has under-performed most global markets. The rupee is currently seen as among the more vulnerable currencies due to the massive deficit. As of Friday, a trend of profit-taking was evident across the stock market and if this continues, the settlement week may see a trend of falling prices.
There is likely to be a greater focus on index instruments to the exclusion of stock futures leading to a higher hedge ratio. High hedge ratios exist where attention is on systematic risks affecting all businesses rather than unsystematic risks affecting specific stocks. Hedge ratios are high at the moment and liable to rise through the April and May settlements. Although there would be room for stock-specific plays as results start to flow, elections and systematic risks will remain top of the mind. Most stocks will track the main market index. The BankNifty and the CNXIT are also likely to be strongly positively correlated with the Nifty. The BankNifty has a high beta, so it will move more exaggeratedly than the Nifty. The CNXIT is likely to be influenced by the rupee’s continued weakness and that may mean less synch with the Nifty.
Directionally speaking, it is much easier to make calls about the next two settlements than about the next week. During the month-long general elections starting April 16, prices are likely to be volatile and have a downwards bias. That’s always the pattern during elections.
However, next week could see the market behaving three ways. If profit-booking continues, prices will slide back towards the 2,600-mark or lower, to test support at 2,500. If FIIs resume buying after taking the weekend off, the market could push beyond the 2,950 mark by settlement. It is also possible that we will see 150-point daily high-low ranges without much net change in index levels.
One can stack up the evidence for any of those scenarios without being able to make a definitive judgment. Volatility is likely to spike but, directional indicators are balanced. Friday did see clear weakening of the uptrend and bearish double-tops appeared at around 2,830. But, the Nifty put-call ratio is bullish and high carryover is often associated with positive sentiments. My gut feel is a downtrend will result but, staying braced for both-ways movement is the logical action. If a trader chooses to bet both ways on the April settlement, April option straddles at around 2,800 or strangles could serve the purpose. In the context of the next four sessions, any option that is close to money is liable to be struck if volatility improves. The risk-reward ratios for March bullspreads and bearspreads are both acceptable. If you are selling short March strangles, stay about 200 points from money. The focus range for the March settlement would be 2,600-3,000.
A bullspread with a long March 2,800c (46) and short March 2,900c (11) costs about 35 and pays a maximum of 65. A bearspread with long 2,800p (45) and short 2,700p (14) costs about 31 and pays a maximum of 69. Combining these creates a long straddle at 2,800 and a short strangle at 2,700, 2,900. The cost would be around 66 and the maximum return would be 34 if one leg of the position was realised. There is a chance that both legs would be realised if the market swings between 2,700 and 2,900 by Thursday.
If April options are utilised, the expiry risk is eliminated, allowing traders to go far from money to set up better risk-reward ratios. A long April 3,000c (45) and a long April 2,600p (62) costs 107 and this can be offset with a short 3,200c (11) and short 2,400p (28). The net cost of this long strangle-short strangle combination is 68. The maximum return on a trending move is 132 with breakevens at 2,532 and 3,068. There is a fair chance that this position will be profitable.
Other possibilities include April bullspreads with long 2,900c (79) and short 3,100c (22) and April bearspreads with long 2,700p (92) and short 2,500p (42). The cost-to-maximum return ratios are 57:143 and 50:150, respectively. A directional trader would ignore the bullspread possibilities because of elections. Another possibility is to wait until settlement and then buy naked far-from money April puts at say, 2,500p or 2,400p. These could gain sharply in a scenario where the market collapses.
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