Traders should keep a target range of 4,600-5,000 for the settlement.
Carryover into the March settlement is strong and the expiry effect is throwing up some interesting spreads. FIIs have cut back derivatives exposure.
Index strategies
The March settlement begins with the Budget so high carryover is understandable. Around 25 per cent of Nifty futures open interest (OI) is in March-April and around 45 per cent of option OI has also moved beyond February.
Derivatives volumes have been reasonable though cash volumes have dropped. The FIIs hold 32 per cent of OI, which is lower than normal. There is one interesting detail that may have some bearing on their attitude. There is substantial difference between the RBI reference rate and the last quote of the USDINR future. The Friday RBI rate was Rs 46.47 while the dollar-rupee future settled at 46.32. So the rupee is expected to harden. One way is through strong FII buying. Of course, the rupee may also harden in response to the recent Fed rate hike.
Carryover is likely to be very strong and an expiry effect is also evident as premiums far from money have dropped sharply. Historical volatility wasn't too high in the past five sessions and that has led to low implied volatility. This may create an opportunity since volatility is usually high around Budget and at current premiums, attractive risk-reward ratios are available close to money.
The premium difference between any February strike and the same March strike is a benchmark for traders. For example, assume a trader sells February 5,000c (10) and buys March 5,000c (92). This standard rollover contract, or calendar spread, costs 82.
The maximum loss is 82, if both contracts expire without being struck. If the February contract expires without being struck, and March is struck, (the market hits 5,000 after February 25) there is some return. If the market hits 5,000 by February 25, gain depends on differences in sensitivity of premiums to changes in underlying.
Returns in theory are unlimited. Similar considerations hold for put rollover contracts where February out-of-money strikes are sold and the same March strikes bought. A trader must consider the risk-reward ratio of a standard March bullspread or bearspread against the maximum loss on these “rollovers”. A March bullspread or bearspread costs less. But there is also a limit on possible return on the bullspread or bearspread.
Directional movement is likely to be negative in the immediate future. The February put-call ratios (PCR) are below 1 and that is bearish. The next 10 sessions will probably see range-trading between 4,650 and 4,950. There will be bursts of short-covering and sudden jumps as Budget-related rumours surface.
Traders should keep a target range of 4,600-5,000 for the settlement. Breakouts beyond will mean 150-200 point trending moves. Standard CTM spreads have excellent risk-reward ratios. However, if you want to gamble on a big move beyond 4,600-5,000, use March options.
The February call options chain shows OI is focussed on February 4,800c (82), 4,900c (32) and 5,000c (10). The March call chain has high OI in 4,800c (186), 4,900c (135), 5,000c (92) and 5,100c (60). A standard CTM bullspread of long February 4,900c and short 5,000c costs 22 and pays a maximum of 78. A far from money March bullspread of long 5,000c and short 5,100c costs 32 and pays a maximum of 68.
The February put chain shows OI concentration in 4,500p (3), 4,600p (6), 4,700p (17) and 4,800p (39). The March put chain shows OI concentration at 4,500p (63), 4,600p (86), 4,700p (113), 4,800p (149) with very high OI at 4,500p. A CTM bearspread of long February 4,800p and short 4,700p will cost 22 and pay a maximum of 78. A March spread of long 4,700p and short 4,600p will cost 27 and pay a maximum of 73.
Combining the February CTM spreads - long 4,800p, long 4,900c and short 4,700p, short 5,000c costs net 44 with breakevens at 4,756, 4,944. The maximum return on a one-way move to 4,600, 5,000 is 56, while a two-way move to both limits could return about 156. This long-short strangle is reasonable. We expect the market to traverse this range and there is a good chance of pay-offs in both directions.
Wider strangles like a long March 4,700p (113) and long March 5,000c (92) can be offset with a short 4,500p (63) and short 5,200c (37) for a net cost of 105. The breakevens are at 4,595, 5,105 and the maximum one-way return is 95. The risk-reward ratio is average, but the position is worth considering since the Budget could cause a breakout to either limit of 4,500, 5,200.
| STOCK FUTURES/OPTIONS The stock futures market is focussed heavily on the top 20 contracts at the moment. Moves close to Budget tend to be sector specific. Most pivotals are balanced close to key supports. If the supports hold, there would be a big technical bounce whereas downside breakouts will mean sharp drops. In most cases, naked stock futures in high-beta counter should be hedged against the relevant index. |
In two sectors, naked stock futures seem reasonable. All the sugar majors are sliding. Shorts in Bajaj Hindusthan, Renuka and Balrampur Chini could work. Sugar is not highly correlated to the Nifty. The other uncorrelated sector is energy. Most energy counters are seeing speculative buying in the hopes of further decontrol. This may not occur but the bulls will hang on till March settlement. A long position in Cairn for instance, could be lucrative.