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| High carryover in range-bound market |
| Devangshu Datta / New Delhi Nov 16, 2009, 00:21 IST |
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A breakout is more probable, since the market rarely range-trades inside 150-200 points for extended periods.
The derivatives market continues to generate high volumes and see a build up of open interest. The spot market is range-trading at the moment but it seems carryover will be good.
Index strategies
Week on week, Nifty futures contracts have seen a rise of 15 lakh in open interest (OI). The CNXIT futures and Bank Nifty have also seen rising liquidity and OI. There's a fair amount of OI in the December series of Nifty and Bank Nifty as well as various stock futures. This suggests carryover will be strong regardless of market direction. Of the subsidiary indices, the CNXIT rose sharply despite rupee hardening to 46.4. The dollar and rupee positions suggest market expectation is now that the rupee will soften a little, and that could drive the CNXIT up further. The Bank Nifty rose on short-covering. Both sector indices would outperform the Nifty on the upside.
Historic volatility (HV) dropped as the market remained locked inside a narrow range with indeterminate trend. As usual in such situations, premiums distant from money saw a drop since expectations of future/ implied volatility (IV) eased. This has led to an accelerated expiry effect, which one would not expect until the last four days of settlement when there is full margin. The risk-reward ratios for spreads slightly distant from money look very attractive.
Technically speaking, a breakout within the settlement is more probable than not, since the market rarely range-trades inside 150-200 points for extended periods. If the Nifty drops below 4,800 or rises above 5,100, there would be a sudden rise in HV and IV. It's possible that either 4,600 or 5,300 will be hit within settlement.
The trader gambling on a breakout could use the early expiry effect to set up cheap strangles with excellent potential returns. This is what a Taleb-style player would do. The odds of this working are better than normal because there are an extra five sessions.
However, it is better to stay inside the current trading range with tight stop losses. Close to money spreads also have reasonable risk-return ratios and a nimble trader could make money on both sides if range trading continues. The put-call ratio for Nifty options and for the overall market suggests imbalance. It was at 1.3 on Friday for the entire market and the November Nifty series had a PCR of 1.8 (in terms of OI). This is extremely high. The classical interpretation is that the market is very oversold and ready for a big Northwards move. This is not backed by other indicators. The technical chart pattern in fact suggests that range-trading could continue, implying a short-term correction since the Nifty is trading near the top of the range of 4,850-5,050.
In practice, we've seen very high PCRs correct in another way. The PCR is a sentiment indicator, and this imbalance has developed due to three successive sessions where the market has turned South after hitting resistance around 5,020. Traders have extinguished calls and taken puts in the expectation that the market will continue range-trading.
If they are right, the PCR will correct down as puts are cashed and call OI builds up at the lower end of the range. This seems more likely than an immediate breakout. A technical issue for options trader is that the market is very close to 5,000. In effect, the 5,000c (92) and 5,000p (90.3) are both on the money. A look at OI across option chains shows expectations. In the call chain, OI peaks at 5,000c and drops sharply beyond 5,200c with a lot of in-the-money positions between 4,700c-4,900c. In the put chain, OI peaks at 4,800p and remains high till 4,500p
A long straddle at 5,000 costs 182 and breaks even at 4,818 and 5,182. Close to money bullspreads and bearspreads are reasonable with a long 5,000c and short 5,100c (47) costing 45 and paying a maximum 55 while a long 5,000p and short 4,900p (56) costs 44 and pays a maximum of 56. However, if the trader moves one step away, the risk-return equation improves sharply. For example, a long 5,100c and short 5,200c (21) costs 26 and pays a maximum of 74. A long 4,900p and short 4,800p (34) costs 22 and pays a maximum of 78. These are well worth taking since the expiry risk is not as high as normal. Similarly, a long strangle of long 4,800p and long 5,200c costs just 55 and it can be laid off with a short 5,400c (4) and short 4,600p (12) to reduce net cost to 39. This is a Taleb-style position that works very well on a breakout though it is not a very high probability. A move to either limit will return 161 and a move between 4,600-5,400 would generate about 361, though that is very unlikely.
STOCK FUTURES/ OPTIONS
Apart from pivotal bank and IT shares, the usual suspects from real estate (Unitech, DLF and HDIL) have been generating high stock futures volumes. There are quite a few metal stocks as well (Tata Steel, Jindal JSW, Sesa Goa) among the top contracts along with perennials like Reliance Industries, Reliance Capital and Suzlon.
The directional patterns are mixed---real estate could be oversold and ready for a bounce while metals may be ready to react. Most financial sector stocks seem bullish. The other interesting group is PSUs, such as SCI, ONGC and Sail, which are all looking bullish and moving on high cash volumes. Out of these, Neyveli Lignite seems most interesting. We've seen a bull run develop in this scrip over 10 days and it could go further.
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