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| Short-term indicators positive | |
| Devangshu Datta / New Delhi July 20, 2009, 0:57 IST | |
 The July put-call ratio is at 1.35, which is clearly bullish
The derivative market is generating near-record volume. At the same time, the FII share of open interest has dropped to around 32 per cent in the past week – it's averaged 38 per cent in the last couple of years. This suggests that well-heeled Indian operators are entering F&O since individual traders rarely keep overnight positions.
The carryover pattern is high, given that there are 9 sessions to go for settlement and 5 to go before full margining. Around 12 per cent of Nifty futures OI and 32 per cent of index option OI is already in August and beyond.
This has led to positive carry with the August Nifty futures trading at a premium to July (and July at premium to spot). Unfortunately, the differential isn't enough to arbitrage. Hedge ratios are also high - understandable since the market has been through correction and trend reversal. The index swung over 9 per cent last week and 9 per cent the week before that, in the opposite direction.
Trader focus is sharply on the Nifty and subsidiary indices. Is the correction over? It seems so, given a dramatic v-shaped recovery. However, it would be sensible to stay braced for 150-point daily swings. A technical case could be made for the Nifty going anywhere between 3,900-4,700 in the July settlement. That's a very wide range. In “least case” scenarios, be prepared for 300-point moves in either direction.
As of now, the short-term indicators appear positively inclined. Quite apart from volumes, which are good in cash and derivatives, the put-call ratio (in terms of OI) is overall at 1.1, with the July PCR at 1.35, which is clearly bullish. However, the August-September PCR is 0.85, which is equally clearly bearish, according to the usual analysis of PCR.
Does this mean a lot of hedgers or is the market genuinely overbought in the timeframe of the next two months? August-September Nifty calls (which are in excess of puts) may be held by people who don't have cash exposure. These calls may also be held by sellers in cash, (who are hedging across timeframes). Or they may be held by people who are buying in cash (Texas hedges).
A larger share of OI than normal is held by Indian operators, who tend to be leveraged to the max and fond of Texas hedges. This leads one to suspect that the derivatives is overbought and cash is likely to be heading there. In that case, the market will pullback.
For what it's worth, an examination of December 2009 contracts suggests that most of the end-of-year call volume is concentrated on breakevens between 4,500-4,800. Similarly, the December 2009 put-volume is mainly concentrated on breakevens between 3,600-3,900. That suggests mini-max expectations of 3,600-4,800.
Given that the market has swung between 3,900-4,700 in the past five weeks, this is a very narrow range on a six-month timeframe. Most of the December option volume is institutional in nature and the narrow range suggests that a large chunk of “smart money” could be caught on the wrong foot if the market continues to trend as sharply as in the past three months.
Apart from the Nifty's movements, here are a few other short term possibilities to consider. One is that the Bank Nifty has a very good correlation to the Nifty and a high beta. So, if you are intending to take directional futures positions, consider taking long/short Bank Nifty positions rather than long/short Nifty or Mini-Nifty.
Another point is that the CNXIT has outperformed in the recent past and it has defensive strength. The CNXIT could be a hedge if you think the overall market is headed for a fall and the rupee will drop as well. On the other hand, if the Nifty's uptrend gets stronger as a result of FII buying, the rupee will strengthen and the CNXIT will lag.
In the options segment, a bullspread close to money with long 4,400c (96) and short 4,500c (57) costs a net 39 and pays a maximum 61. A bearspread CTM of long 4,300p (72) and short 4,200p (44) costs 28 and pays a maximum of 72. Both have risk-reward ratios and a combination of them would give a long-short strangle set that costs 67 and paid a maximum of 33 with breakevens at 4,233 and 4,467.
A wider strangle of long 4,500c and long 4,200p costs 101 and can be offset with a short 4,000p (16) and short 4,700c (16) for a net cost of 69. The maximum return would be 131 on a one-sided move with breakevens at 4,131, 4,569. This is quite attractive since the market could swing that much in the next nine sessions. It beats alternative two-way constructs of long future/bearspread or short future/bullspread.
STOCK FUTURES/ OPTIONS
When the hedge ratio rises, interest in the stock F&O segment tends to narrow. Apart from the usual suspects, very few stocks are generating notable futures volume. Among bank shares, DCB is a potential long position that could outrun the Bank Nifty. Reliance Capital is another non-banking stock that could outperform. Larsen is also looking like an interesting long position as is Suzlon.
Sterlite is a potential short while other metal stocks are potential longs. Among metals JSW Steel is among the more interesting long positions because it is generating unusual high futures volumes and it could have an upside till around Rs 700. Go long with a stop at Rs 575.
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