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| Go with far from money spreads |
| Devangshu Datta / New Delhi Sep 28, 2009, 00:29 IST |
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A far from money bullspread of long 5,100c and short 5,300c offers good risk-reward.
Going into the October settlement, there was low volatility, and relatively low carryover and relatively low volumes. The market traded near its 2009 high through last week, but the tapering down of trading interest could result in a correction.
Index strategies
The festive season normally sees lower volumes since Indian operators go on vacation. As a result, the market trend is often bearish. However, the FIIs stepped up buying substantially in September.
They will play a crucial role in moulding sentiment if they retain a positive attitude. Right now, the FIIs hold around 38 per cent of all derivative open interest (OI).
Last week saw a statistical quirk in terms of volatility readings. The Nifty's average daily high-low range remains around 125 points as it has for several months. However, as a percentage of index levels, this 125-point range is considerably lower (1.6 per cent) than a couple of months ago. Importantly for a trader, last week's high-low range was pretty much the same as the average daily high-low range. This means, two successive trending sessions would cause a breakout.
The lower volatility has also led to lower premiums. Carryover was lower than one would have expected in a settlement with net gains, and this may also have something to do with low premiums. While a low Vix is generally taken to indicate good sentiment, a very low reading is a potential danger signal. The absence of fear is often associated with significant market tops.
Low volumes could correct to some extent next week. Post-carryover, the hedge ratio is on the high side and OI is considerably lower than it was before settlement day. There should be a build up in OI next week despite the holiday season. It may also be noted that October is a long settlement.
Several signals look healthy. The Nifty option PCRs are all in the bullish zone, hovering between 1.4 for October, 1.3 overall and 1.1 for November-December. Around 55 per cent of option OI is in October. The Nifty and BankNifty futures are trading at small premiums to respective underlyings, while the CNXIT is at a nominal discount. This indicates steady or bullish sentiment.
While OI in the Nifty futures isn't very high yet, both the Bank Nifty and the CNXIT are relatively well-traded. As to future direction in both indices, the evidence is mildly negative. The CNXIT has outperformed in the last couple of months, despite periods of rupee strengthening. However, the big three – Wipro, Infosys and TCS all saw sell offs on Friday and a negative trend in these three could continue. It is practically impossible for the CNXIT index to rise in defiance of these three scrips.
The Bank Nifty has underperformed on fears that interest rates could harden. The latest inflation numbers make that more likely. Here too, a sell off was visible in the bigger counters on Friday.
Traders should note that with October being a long settlement (September 24-October 29), there is time to set up option spreads far from the money. The risk-reward ratios are quite good, even for spreads close to money.
An examination of the Nifty option chain for October shows that there's a falling off in OI below the 4700p (30.4 lakhs OI) and above the 5300c (31.8 lakh) with the 4600p (21L) and the 5400c (10.8L) registering much less OI. Adjusting for premiums therefore, 4650-5337 seems to be the consensus limit for October trading expectations.
Given five weeks, the implied movement of +/- 400 points could be a little low with the market fluctuating through a high-low range of 125 per session. Three trending sessions may move the index beyond expectations and we know that any move outside the consensus limit sets off panic, as traders then scramble to readjust.
A CTM bullspread of long 5,000c (130) and short 5,100c (87) costs 43 and pays a maximum of 57. A CTM bearspread of long 4,900p (119) and short 4,800p (85) costs 34 and pays a maximum of 66. Note that CTM puts are slightly less expensive than equivalent calls – this suggests the average trader is more focussed on the upside.
A FFM bullspread of long 5,100c (87) and short 5,300c (33) would cost 54 and pay a maximum of 143 – that translates into a risk-reward ratio of 73:27. An FTM bearspread of long 4,800p (85) and short 4,600p (41) costs 44 and pays a maximum of 156 for a risk-reward ratio of 78:22. These two wide FFM spreads are still inside October trading expectations.
Combine the above FFM spreads and you will get a long strangle at 5,100c and 4,800p coupled to a short strangle at 4,600p and 5,300c. The total cost would be 98 and the maximum payoff for a move to either limit would be 102, with breakevens at 4,702, 5,198. This isn't a bad risk-reward ratio since there is a good chance that the market would travel in both directions within the settlement.
STOCK FUTURES/ OPTIONS
On the long side of the stock futures market, positions in pharma scrips like Sun, Dr Reddy's and Cipla could be worth investigating. Real estate stocks like DLF, Unitech, HDIL and Indiabulls Real Estate are all likely to move in the same direction as the market, but they have exaggerated betas. So, if a trend is apparent on Monday, it may be worth going with a real estate stock rather than the Nifty.
On the short side, apart from ICICI Bank, SBI and Infosys, the most interesting positions could arise from metals. Sail, Tata Steel and Sterlite all look weak. However, the clearest downtrend is visible in Sesa Goa, where the scrip has seen a sharp correction following a steep climb.
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