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| Low volatility, early expiry |
| Devangshu Datta / New Delhi Sep 14, 2009, 00:37 IST |
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The trend of lower F&O volumes is a bearish signal since it may mean future lack of interest
Trading volumes eased in the derivatives market as the cash market locked into a narrow range. FIIs cut back on derivatives exposure though they were heavy net buyers.
Index strategies
An analysis of buy-sell positions is interesting. Last week, DIIs were net buyers to the tune of Rs 177 crore while FIIs bought Rs 2,940 crore. By inference, retail traders and operators sold.
The profit-booking by Indian traders may be prompted by a desire to clear positions before going on holiday. Traditionally Indian traders have been net sellers during the Diwali run up and immediately post-Diwali.
DIIs have been steady buyers through the last several months while FIIs have been net sellers during the same period. So the “Firangi” buying in a week where there are no settlement considerations could mean a genuine change in attitude.
Usually when FIIs are net buyers, they increase derivatives exposures. The current cutback in exposures could mean long-term, unhedged buying. If true, this is a bullish signal since such a persistent trend would create a floor for equity prices.
In general though, the trend of lower derivatives volumes is a bearish signal since it may mean future lack of interest. Confirmation would come if there’s low carryover into October. This could cause a short-term downtrend if Indian retail traders and operators sell into every rally.
Last week, the indecisive tug of war between Desi bears and foreign bulls translated into abnormally narrow range trading. The Nifty has traversed an average high-low range of 125-130 points per session in the past six months. The last four sessions stayed between 4,790-4,890.
The lack of volatility may have induced some exits. But the index is very unlikely to stay inside such a narrow zone. At the least, the range will widen to around 200 points – perhaps 4,700-4,900 or 4,800-5,000. Larger moves are likely as well.
Although trading volumes were on the low side, open interest (OI) rose in index futures and index options. But most of the focus was on September. It’s a relatively early settlement so lack of carryover is a little disturbing. At this instant, around 97 per cent of Nifty futures are in September – with nine sessions to go, one would have expected this to be no more than 90 per cent. The index option carryover is more heartening, with just 58 per cent of Nifty option OI in September.
All three traded index futures settled at premium to spot. The Bank Nifty registered extraordinary gains (6.3 per cent) last week while the CNXIT (+1.7 per cent) underperformed the Nifty (+3.2 percent). The rupee strengthened last week and is likely to strengthen further if the FIIs continue buying. That could keep the IT index under-par. The Bank Nifty may be able to maintain its bullishness however and a long position here is still reasonable.
As to the put-call ratio (PCR), the index option PCR in terms of OI is bullish. In fact, the September PCR of 1.7 is in the red zone because it’s quite a bit higher than normal. The overall PCR of 1.4 is also high but closer to normal.
One classic way to trade a low volatility situation is to sell strangles at some distance from the money. This is tempting due to the expiry factor, which will cause rapid decay of out-of-money premiums. A short strangle can be laid off for greater safety by taking a long strangle even further from money.
Any trader who decides to do this should cater to the possibility of a 200-250 point swing. This translates into two successive trending sessions. Hence the short strangle would have to be something like short 4,600p (29) and short 5,000c (36). That generates a net premium inflow of 31 if it’s laid off with a long 4,500p (17) and a long 5,100c (17). The maximum loss would be 69 on a move to the limit with breakevens at 4,569 and 5,031. This is barely acceptable, given the expiry factor.
If on the other hand, a trader wishes to gamble on volatility increasing, he could take the reverse of this position with a long strangle at 4,600p and 5,000c, etc. He could also take either a long future coupled to a bearspread as a hedge or a short future coupled to a bullspread hedge. In both cases, the future should be stop-lossed with say, a maximum loss of 50 points.
Normal close-to-money spreads have decent risk-reward ratios with the usual expiry considerations starting to come into play. A long 4,900c (69) and short 5,000c (36) costs 33 and pays a maximum of 67 while a long 4,800p (81) and short 4,700p (49) costs 32 and pays a maximum of 68. So a directional trader may as well flip a coin.
Since both these positions may be struck, they can also be combined for a net cost of 65 and a maximum gain of 35 on a move in either direction. If the market does swing between 4,700-5,000, this long-short strangle combination would gain 70 on an outlay of 65. This is again, quite reasonable, if you expect a wider ranging market.
STOCK FUTURES/ OPTIONS
Apparent weakness in the real estate sector throws up the possibilities of shorting DLF, Unitech, IBREL and HDIL since these are all highly traded. Another sector, which could throw up shorts is PSU refiners – both HPCL and BPCL look weak.
Metal stocks such as Sterlite and Sesa Goa also saw sustained selling on Friday. On the long side, SBI and IFCI offer potential long positions. But the most attractive long position is probably L&T which surged on high volumes during a lacklustre Friday.
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