Bullish within a narrow range

A correction that ends above 4,600 would not alter the intermediate bullish perspective

A strong derivatives carryover trend and short-covering from FIIs triggered an upside breakout during settlement week. Sentiment seems to be quite bullish. But a short-term correction could be around the corner.

Index strategies
The FIIs bought over Rs 1,300 crore last week after sales of over Rs 4,000 crore in the first three weeks of August. They also increased derivatives exposure to 38-40 per cent of all open interest (OI), up from 32 per cent of OI five sessions ago. That was enough impetus for a breakout.

Carryover patterns were strong across stock futures as well as index instruments. Hedge ratios fell as did the Vix. These are bullish sentiment signals. All three liquid September index futures are at premiums to their respective underlyings, which is another bullish sign. The Nifty option put-call ratio (PCR) is also bullish. The overall PCR in terms of OI is 1.2 with the September PCR at 1.45.

The CNXIT, which has outperformed the Nifty and Bank Nifty in the recent past, saw rising OI while the Bank Nifty continued to generate high OI despite the sector under-performing. Traders are apprehensive of a rate-hike due to the inflationary pressures of higher fuel prices. The CNXIT is reverse-correlated to the rupee though it’s less connected than earlier. If the FIIs continue to buy and there is a rate hike, the rupee could strengthen with a negative effect on the CNXIT.

The Nifty’s carryover patterns have good volume and OI. But the index futures are heavily concentrated in September with over 98 per cent of Nifty futures OI in that month. Nifty Option OI is spread more evenly with around 60 per cent in September. Expect more OI in October this week. There could be calendar spread possibilities if the focus remains on September Nifty and September-October prices diverge.

The breakout could reach a target of 4,900-5,000 by mid-late September. But in the shorter term, there’s a strong chance of correction. Technically, a correction ending above 4600 would not alter the intermediate bullish perspective.

So the current trading focus should be 4,600-4,900 with some weight given to a short-term downtrend. If the Nifty drops below 4,600, the breakout will have failed and the downside could be 4,350-4,400. The daily high-low Nifty range is averaging around 125-150 points. So, two strongly trending sessions would breach the limits of 4,600-4,900.

OI data across September index option chains shows that trader expectations are focussed within 4,600-5,000. The peak call OI is at 4,800c with over 1.3 lakh contracts. There are over 65,000 contracts at 5,000c and only 26,000 contracts at 5,100c. For September puts, the peak OI is over 1.3 lakh contracts at 4,600p. There are over 15,000 contracts at 4,000p and 8,400 contracts at 3,900p.

An option trader has several choices. He could stay close to the money with reasonable risk-reward ratios in either direction. He could take positions that gain on big moves, regardless of direction, by using strangles or future and option combinations. He could gamble on the market staying range-bound and sell options outside 4,500-5,000 range.

A CTM bullspread like long 4,800c (130) and short 4,900c (90) costs 40 and pays a maximum of 60. A CTM bearspread like long 4,700p (142) and short 4,600p (103) costs 39 and pays a maximum of 61. The bearspread is marginally better because it’s closer to the money.

A long strangle–short strangle combination like long 4,600p and long 4,900c offset by short 4,400p (51) and short 5,100c (38) costs a net 104 and pays a maximum 96. This is not ideal. The risk-reward ratio is worse than 1:1 and it’s some distance from the money.

A long future with stop loss set 50 points from the money can be coupled with a bearspread or a short future with a stop loss set 50 points from the money can be coupled to a bullspread. The short future and bullspread loses a maximum of 90, with unlimited gains if the market drops, while the maximum upside gain is 10. The long future and bearspread loses a maximum of about 75, the upside gain is unlimited, while the downside gain is a maximum of about 25.

A reversed bearspread far from money such as a long 5,000c (60) and a short 5,100c (38) pays an initial 22 and loses a maximum 78. A reversed bullspread of short 4,400p (51) and long 4,300p (35) pays an initial 16 and loses a maximum of 35. These positions have adverse risk-reward ratios and as it is right at the beginning of the settlement, the risk is fairly high.

Net-net, the payoffs for non-directional strategies are not very attractive. Option selling carries fairly high risks. Hence, it may be best to go with directional strategies. The futures and spread positions are viable. If you’re trying to maximise, consider a CTM bearspread, hoping for a short term downtrend. If that works, you can then switch to a long future. 

STOCK FUTURES/ OPTIONS

In the stock futures segment, there are a lot of interesting bullish plays and very few shorts. Aban is consistently logging high activity and may be worth a long position. Infosys and Sterlite may be set for up moves. But the most interesting of long positions seems to be Reliance Capital.

Keep a stop at Rs 855 and go long. The real estate sector has seen prices rise on slightly weaker than expected cash market volumes. Along with banking, realty would suffer most from a rate hike and if that happens, shorts in real estate stocks will be on the cards.