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| Nifty bearspreads offer the best payoffs | | DERIVATIVES |
| Devangshu Datta / New Delhi Sep 29, 2008, 00:38 IST |
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The 3,800p-3,900p bearspread seems to have a good risk-reward ratio.
Moderate carryover characterised the start of a bearish-looking October settlement. The market drifted lower once the short-covering ended on Thursday.
Index strategies
Carryover was on the moderate-to-low side with large volumes on Wednesday and Thursday as positions were extinguished. Friday was a very low volume session in both cash and F&O markets.
Some of the volume dip was due to the lack of counterparties prepared to take the long side of futures transactions in both stocks and indices. The volumes and open interest of index futures and options was very high as a percentage of the total volume, which is another sign of a nervous and narrow market.
One good sign is that the FIIs did increase their F&O commitments in the first session of the new settlement, rising to around 39 per cent of all OI. Interestingly, their index option exposure is around 37 per cent of their total OI while the index futures exposure is around 20 per cent with stock futures at 42 percent. That’s an unusual composition – usually the FII stock and index futures exposures are both far higher than index options.
Index options are generally hedges and we’ve seen in the past that a high index option exposure by FIIs is often indicative of a change in their attitude. I would assume that the bulk of the stock futures and index futures are shorts pyramided on top of continuing cash market sales. The index options are hedges. Once the FIIs stop selling and cover their shorts, the index options are also likely to generate profits as the market trend moves up.
Balanced against the potentially positive change in FII attitude, we have several signs of an extremely weak market. Index futures settled at a mild premium to cash levels but that was because the cash market softened considerably in the last hour and the index futures did not slide quite so hard. The Vix is fairly high at around 34 as well and that again signals likely high volatility and a downtrend.
The CNXIT and Bank Nifty both lost considerably more than the market indices. These two influential sector indices continue to look bearish. That makes it more likely that the market will continue to head down given the number of index heavyweights in banking and IT.
In the options market, the put-call ratios were almost uniformly bearish. The overall market PCR was below 0.7 while the index options PCR was at 0.7. In terms of OI, the index options PCR was at 1.2 overall which is neutral. However, the October PCR was at 0.86 which is quite bearish.
The movement in the December options market is interesting. December 2008 is now the far month of the normal series but it was the first month where long-term contracts were offered. So it has plenty of OI. The high OI puts in the Dec 2008 series have breakevens ranging from 3,400 to 3,800. The high OI calls in Dec 2008 have breakevens ranged between 4,600 and 5,000. So, we have ranged limits of expectations from both optimists and pessimists.
In technical terms, the market is almost guaranteed to test 3,800 again within the next few sessions. The upside seems limited at the moment since there is heavy resistance banded above 4,000 and a rise beyond 4,200 seems unlikely. October is a long settlement, however and if the market stays bearish, 3,800 will be broken within the settlement. Since we are in a new intermediate downtrend, a major upside seems unlikely.
An options trader who was feeling optimistic can actually look at cheap calls beyond say 4,300 in the expectation that the premiums will rise if the market moves. However, a more conventional bearspread strategy should work well enough on the downside. It’s not necessary to take very close to money positions since the settlement has just begun.
The risk-reward payoffs are skewed because the market has settled very close to 4,000. As a result, in-the-money call premiums are high. Unfortunately, there’s no liquidity below 3,750 in the put chain.
This has two implications. One is that 3,750-3,800 is a very strong support, which we already know since the market has held at 3,790 twice in the past three months. The second implication is that if the market falls below 3,750, it would slide further on frantic selling.
A long 4,000c (176.15) versus short 4,200c (91.6) should cost about 85 and pay a maximum of 115. Further from money, a long 4,300c (62.1) and a short 4,400c (42.1) costs just 20 and offers a maximum return of 80. This is unlikely to be struck or fully realised.
But an upmove would certainly swing a profit since the 4,300c will rise much more than the 4,400c on an uptrend. A long 3,900p (136.1) and a short 3,800p (103.7) would cost about 33 and pay a maximum of 67. In practical terms, the 3,800p-3,900p bearspread seems to have a good risk-reward ratio. If you do want to stay long, go far from money.
STOCK FUTURES/ OPTIONS
Two unusual stocks feature in the “most active” list. Punj Lloyd and Suzlon have both seen massive selling and look to be tempting shorts. Keep a stop at 185 in Suzlon and at 295 in Punj Lloyd. Apart from these two, most of the other majors seem to be showing negative trends as well.
NTPC is another unusual entrant a fair amount of OI in the 175c (8) and 180c (5.85) and 190c (3.15). A bullspread may be worth trying with the underlying at about 174.
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