Jan F&O settlement could be volatile

In a wider framework, sentiment may be good until the Budget

The stock market continued to log gains. The European Central Bank’s decision to start it’s a quantitative easing programme has ensured liquidity will continue to be easily available. Based purely on technical signals, we expect the bull run to continue indefinitely. In a wider framework, the sentiment might be good until the Budget. The risk is primarily external. Asian markets continue to be nervous about China, US earnings results have not been up to expectations and Europe could see some turmoil if Greece pulls out of the euro zone.

The settlement could be volatile. A driver is the public sector undertaking (PSU) disinvestment programme, though this might cut both ways. The sentiment is bullish but greater liquidity could lead to a sell-off in specific PSUs. On Wednesday, the Nifty tested resistance at 8,975 before falling back to test support at 8,875. Both the Nifty and its major driver, the Bank Nifty, hit a succession of new highs. The Nifty ended just above 8,900, while the Bank Nifty hit 20,907, before pulling back to 20,450.

Given the succession of new highs, trend followers will advocate staying long until there is some clear indication of a trend change. The breadth looked poor on Wednesday and there could be a correction before the next surge.

Foreign institutional investors (FIIs) have been very positive and that has been the only driver, given the domestic institutional selling; volumes are moderate. The Nifty could slide till 8,625 if there’s substantial selling. The short-term trader can assume congestion at every 50-point interval.

The rupee has strengthened against the dollar and stabilised temporarily. As long as FIIs keep buying, the dollar-rupee exchange rate will not be under pressure. The rupee has also strengthened against the euro, from 85/euro to below 70 and this trend could continue.

The Bank Nifty’s trend is likely to be the major driver. Traders taking long positions in either Bank Nifty futures or options should be prepared for a reaction to trigger short-term pull-backs till 19,750. Stop losses must be set accordingly.

Given the expiry, a one-session position of long January 8,800p (4) and long 9,000c (4) is a potential gamble. If either end is struck, there could be a massive return. This close to settlement, the put-call ratio (PCR) is not a very useful indicator. For what it’s worth, the three-month PCR is very high at 1.5.

The February Nifty call chain has open interest (OI) peaking at 9,000c, with a slightly smaller OI bulge at 9,200c and ample OI till 9,500c. The put OI is ample, at 8,000p-9,000p, with three large peaks at 9,000p, 8,500p and 8,000p.

On Monday, the spot Nifty closed at 8,915, with January futures at 8,905. There will be volatility in February and traders can look at very wide spreads. A bearspread of long 8,800p (115), short 8,700p (89) is attractive, costing 26 and paying a up to 74. Similarly, the bullspread of long 9,100c (115), short 9,200c (81) is acceptable, with a cost of 34, and a payoff of 65.

It is tempting to sell options as well, as the premium usually dips sharply in the first two or three sessions of settlement. If you don’t mind the obvious risks, it’s possible to sell these two spreads, or to sell at more distance from money. A strangle combination of long 8,700p (89), long 9,200c (81), short 8,600p (69), short 9,300c (53) costs 47 and breaks-even at 8,653, 9,347. This isn’t very attractive. A brave trader could reverse it, or just take the naked short 8,700p, short 9,200c. He would hope to cover this zero-delta short strangle with a profit within a couple of sessions.