High volumes and high volatility

If you wish to make a directional bet using index futures, the Bank Nifty will generate bigger swings than the Nifty.

An extraordinary week saw volumes zoom over Rs 100,000 crore as traders scrambled to adjust to a decisive election verdict. The stage is now set for a high-voltage settlement week.

Index strategies
It was clear by May 17 that the market would open high on May 19. But everybody miscalculated levels. Money that had been waiting on the sidelines for months flowed in. Apart from Indian traders and FIs, the FIIs increased their collective exposure considerably.

They pumped in over Rs 5,000 crore on Tuesday alone (around Rs 15,000 crore so far in May). The rupee jumped almost 5 per cent causing a "wealth effect" as bond yields dropped temporarily. The option chain had little open interest above Nifty 3,800 and no open interest to speak of above 4,000.

Most people (including yours truly) assumed the market would open somewhere around the 3,900-4,000 mark. That would have triggered a further upmove on short-covering alone. When the market opened at 4,350-plus on Monday morning, call-sellers and short futures traders were in massive trouble. Their desperate attempts to cover shorts in the face of margin calls and a market-wide upper circuit added to the northward momentum.

At its peak on May 19, the market was at 4,509 – that is, up over 22 per cent from 3,671 where it had closed on Friday, May 15. Of course, there was a correction. post-May 19, there have been alternate waves of buying and selling causing volatile, range-bound trading between 4,100-4,350. Premiums have spiked – the Vix went from 51 (May 15) to 90-plus by mid-week.

Settlement week presents an interesting picture. The trend of carry-over is quite strong. Over 21 per cent of Nifty futures OI has moved to June and beyond. Around 38 per cent of option OI is also in the mid-month and beyond. Despite the expiry factor, open interest in options actually increased on Friday and what is more, it increased in the May series as well as overall.

Volumes will therefore be very high – quite possibly edging to around the Rs 100,000 crore mark. Daily volatility is likely to be in the 3.5-4.5 per cent range or around 150-200 points per session. Lack of recent trading between 3,700-4,100 means that there are also imperfections and gaps in the option chain.

Specifically, there's a sharp drop in the put OI below the 4000p mark and there isn't much call OI above 4,500c either. Most likely, prices will continue to oscillate between 4,100-4,500. But a breakout in either direction could cause chaos since traders will have to scramble as they did on May 18.

Directionality is tough to predict. The short-term trend is negative. Further profit-booking is very likely since the closing Nifty levels of May 22 are 15 per cent higher than the close of May 15. On the other hand, the Nifty put-call ratio for May (in terms of OI) is at 1.4, which is quite bullish. Even the overall PCR (OI) is 1.2, which is either bullish or neutral. One interpretation of the contradictory signals would be intra-day corrections followed by recoveries. But a breakout is possible – for example, trouble inside the UPA could trigger some reaction.

The Bank Nifty, the Junior and the Midcap 50 easily outran the Nifty itself last week. While the other indices' futures have no liquidity, the Bank Nifty will definitely attract attention. It remains a high-beta instrument with a strong correlation to the Nifty. The RBI's refusal to ease monetary conditions further could be a dampener here. If you wish to make a directional bet using index futures, the Bank Nifty will generate bigger swings than the Nifty and in the same direction. All the index futures are at some premium to their respective underlyings. Not surprisingly, the CNXIT underperformed the rest of the market. It gained only 1.3 per cent as the rupee soared.

A close-to-money (CTM) bullspread like long 4,300c (58) and short 4,400c (28.5) costs 30 and pays a maximum of 70. A CTM bearspread with long 4,200p (58) and short 4,100p (29) has almost the same risk-reward ratio with a cost of 29 and max return of 71. A CTM June long 4,300c (175) and short 4,400c (132) also has a decent profile, costing 43. Given the historical volatility, these spreads could all be hit. The June spreads may be worth considering to cater for expiry, since their risk-return ratios are quite good.

In case of strangles, June options are the only realistic instruments. A long June 4,500c (96) and a long June 4,000p (99) can be offset with a short June 3,700p (42) and a short June 4,800c (37). This costs 116 and it gives a maximum return of 184 on a trending move to the limit. More importantly, you are betting on the delta and gamma behaving as usual. That is, you expect changes in CTM option premiums to be greater for changes in underlying price.

 

STOCK FUTURES/ OPTIONS

Most major stocks have a similar pattern to the index. They shot up and then corrected while still registering double-digit gains week-on-week.

As such, several stocks look over-extended. Metal stocks could slide given that global commodity prices have not gained anywhere near as much as Indian metal stocks.

Real estate, especially Unitech and DLF also seem attractive shorts. One contrarian try could be a long TCS position – the IT giant was among the rare losers due to the rupee-hardening and it may bounce next week if there's a correction across the market.