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| Volatility rises as market switches trends |
| Devangshu Datta / New Delhi Nov 30, 2009, 00:35 IST |
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Traders hedged against fall to 4,500.
The November settlement ended with heavy FII selling and a weak trend. Carryover which had been strong, petered off. Volumes remained good and volatility was high.
Index strategies
Bearish global cues had an adverse impact and there were no positive local triggers. Volumes were high in cash as well as derivatives. The FIIs sold heavily but retained collective exposure of about 40 per cent of all open interest (OI) in derivatives.
Volatility spiked in the last three sessions as the short-term trends switched around. This had an effect on close-to-money premiums, which are high. Carryovers tapered off but a lot of fresh positions opened on Friday, which was a high-volume, high-volatility session.
Directionality remains tough to judge. Range trading between 4,700-5,100 appears most likely. But a case can be made for breakouts in either direction. On the downside, the trader would have to be prepared for a drop till 4,500-4,550 levels if the 4,700 support is broken. On the upside, the trader would have to be prepared for a potential breakout till around 5,300.
The Nifty and the CNX IT futures settled at small premiums to the respective underlyings while the Bank Nifty is trading at a discount. OI has risen in all three indices. The Bank Nifty appears bearish and likely to remain so while the Dubai debt crisis is breaking news. Since the Bank Nifty consists of high-weighted stocks, it could have strong influence on the Nifty. The CNXIT also lost disproportionate ground on panic caused by fresh details of the Satyam scam. However, it has a technical upside on short-covering and a positive driver if the rupee stays weak.
Trading strategy should be planned for those three contingencies, range-trading, a downside breakout with a target in the 4,500-4,550 range and a breakout above 5,150 with a target of 5,300.
During range-trading, the trader would have to switch attitude very quickly or risk selling calls and puts outside the trading range. Otherwise, the trader can take two-way positions looking for a breakout, or bet on one-sided movement.
For what it's worth, high volumes and high OI buildups suggest an upside breakout is slightly more likely. Put-call ratios are also bullish. The Nifty PCR (in terms of OI) was around 1.3 with the December PCR at 1.4. These are in the normal to bullish range. Around 71 per cent of all Nifty option OI is in December at the moment.
A look at option chains shows unusual patterns. Usually OI in the near-month tends to cluster close to money, diminishing as strike price moves away from money. But that's not the case in the put chain. The maximum OI is at December 4,800p (premium 101) with a lot of OI at 4,700p (74), 4,900p (138) and 5,000p (186). But there are significant OI clusters at 4,500p (40) and at 4,000p (9) with some OI at 4,300p (22) as well. In the call chain, the pattern is normal with the major OI buildup at 5,000c (132), 5,100c (91) and 5,200c (59).
My interpretation would be that some traders are braced for a potentially sharp fall but less afraid of a sharp rise. The put chain may also normalise a few sessions further into December settlement as positions far from money are extinguished and more OI builds up close to money. Traders will note that premiums are quite high indicating that implied volatility has risen.
Close to money bullspreads and bearspreads offer average to good risk-reward ratios with the bearspreads being better.
The Nifty closed at 4,941. A bullspread of long 5,000c and short 5,100c costs 41 and pays a maximum of 59. A bearspread of long 4,900p and short 4,800p pays a maximum 63 and costs 37. Further from money, a long 5,100c and short 5,200c costs 32 and pays a maximum of 68 while a long 4,800p and short 4,700p costs 27 and pays a maximum of 73.
Strangles are expensive. A long 4,700p and long 5,200c position costs 133 with breakevens at 4,567; 5,332. This could be offset with say, short 4,500p and short 5,400c (22) to reduce cost to 71. That combined long-short strangle has breakevens at 4,629, 5,271, with a return of 129 if there's a move till either short strike. A move between 4,500-5,400 (unlikely) would return something around 329.
An alternate way of building two-way positions is to take a long (short) future with a stop loss coupled to bearspread (bullspread) hedge. Assume say, a 50-point stop loss. A long future (stop loss at 4,890) and a bearspread hedge of long 4,800p-short 4,700p costs 27.
This leads to a gain an unlimited amount beyond 4,970 and loses a maximum of about 77 if the market stays between 4,800-4,890. On the downside, it gains a maximum of 23 if the market touches 4,700. Similarly a short future (stop loss at 4,990) and bullspread hedge of long 5,100c-short 5,200c costs about 32.
This has unlimited gains below 4,910 and loses a maximum of 82 between 5,000-5,100. At 5,200, it would gain about 18.
STOCK FUTURES/OPTIONS
Most of the major stocks are sitting on, or just above key supports. They will either range-trade, recovering along with the market or they will see breakouts in either direction. Banking is among the weakest-looking sectors. There could be lucrative shorts in stocks like Bank of Baroda.
Stocks that could benefit from short covering include Suzlon and NTPC. Few stocks appear to have the ability to stay independently bullish. One of these is Gail, which has seen steady gains through November and may now be set to hit new 2009 highs.
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