Settlement may be upbeat and volatile

While bearspreads have better risk-reward ratios, the odds appear to be in favour of the bullspreads.

The lead-up to the last settlement of 2008 has seen at least what may be a temporary but welcome change in sentiment. Prices are up, volumes good and background signals bullish.

Index strategies
Although FIIs have cut back on their commitments in both cash and derivative segments, they have been net buyers till date in December. As a result, prices have been in recovery mode. The enhanced volumes have come from Indian traders.

Some macroeconomic factors seem to have lifted sentiment. Bond yields have fallen sharply. Commercial rates should follow suit. This has sparked a rally in finance and rate-sensitive stocks. Also, the rupee has climbed, crude prices have dropped and so has WPI. This takes pressure off the trade balance and government finances, triggering hopes of a turnaround in the PSU refining and marketing sector.

All this could be temporary. The FII attitude in 2009 will be crucial and so will Q3 results. Expectations are not high on either front and that is a blessing since it creates the possibility of positive surprises. If the FIIs come back as buyers, the upwards market momentum will accelerate.

Despite rising volumes, the carryover trend is moderate. Around 32 per cent of Nifty futures volume has moved into January and beyond – this is marginally lower than normal. But less than 25 per cent of Nifty option open interest is in January and beyond and that is much lower than normal. The relatively low option OI in mid and far series guarantees that settlement week will see high volume trading. However, it could mean that carryover is lower than normal.

A more unequivocally healthy signal is that futures are generally trading at premium to spot and the January Nifty futures are at premium to December. The trend of carryover with December Nifty being extinguished and January contracts opened is liable to increase the premium of January versus December. There is room for a calendar spread with long December-short January intending to reverse at settlement.

Open interest has increased significantly in BankNifty futures. This is because the sector has moved up strongly. There is room for further gains here on the basis that banks have not yet cut rates and rate cuts should lead to another round of buying in bank shares. It may be worth going long, either in December or January BankNifty.

Technically speaking, the Nifty has a target of about 3,200, maybe more. On the downside, it seems to have support between 2,800-2,900. The range between 2,800-3,200 will be the focus of most traders.

Intra-day volatility has dropped or rather the trend has been more one-way. This has caused the VIX to ease down from recent highs of 70-plus to below 40. This is still quite high in historic terms. One possibility is that the market will mark time through settlement and then move strongly up.

But settlement week usually sees excessive intra-day volatility and this settlement is unlikely to be an exception. It would be prudent to expect at least one 200-point Nifty session next week especially given the truncation due to Christmas and the large overhang of Nifty December options, which must be cleared one way or another.

A lower VIX is usually read as the sign of an optimistic market. This has often been wrong in the Indian context. But it’s backed by good signals from put-call ratios and that has usually been reliable. Overall PCRs are at 0.92, which is bullish. Index PCR is around 1 and PCR in terms of open interest is at 1.5, which is quite strong.

A Narrow December bullspread of long 3,100c (42.9) and short 3,200c (13.3) costs 30 and pays a maximum of 70. A January bullspread with long 3,100c (166.15) and short 3,200c (118.7) costs 47 and pays a maximum of 53. A December bearspread with long 3,000p (25.2) and short 2,900p (7.7) costs 17 and pays a maximum of 83. A January bearspread of long 3,000p (126) and short 2,900p (93.65) costs 32 and pays a maximum of 68.

The extraordinary difference between the risk-reward ratios is due to the fact that the Nifty is trading very close to 3,101 and the 3,000 put is much further from the money. Given considerable expiry risk, it’s better to go with the January series. Although the bearspreads have better risk-reward ratios, the odds appear to be in favour of the bullspreads working.

Another possibility is to take a long January Nifty future with a stop at 3,050 and couple that to a January bearspread of long 3,000p and short 2,900p. This would be profitable if the market moved above roughly 3,135 or below 2,965. It looks like a better way to cater for two-way movement than strangles.

 

STOCK FUTURES/OPTIONS

Most of the movement in stock futures has been one-way. There has been a fair amount of carryover as well. The list of the most active counters includes several real estate stocks like DLF, Unitech and HDIL – they all look bullish and Unitech probably carries the most upside. It also includes Suzlon, NTPC and Educomp apart from the usual suspects like Reliance, Reliance Caps, SBI and ICICI. Suzlon, Educomp and NTPC may have hit resistances on Friday and could be potential shorts.

The Infosys action is in anticipation of Q3 results. However any trader going short should be aware that he is acting against an established and apparently strong trend. Suzlon for example, could be interpreted either way. NTPC does seem to be clearly bearish. Go short with a stop at Rs 187 and a target of Rs 170.