Volatility set to rise

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

A narrow trading pattern never lasts long and one high-volatility session is likely to trigger volumes expansion.

The carryover pattern has been strong and steady going into the settlement week. Recent intra-day volatility was abnormally low and is very likely to rise.

Index strategies

The market suffered net losses while volatility stayed low. Last week’s five sessions saw average high-low ranges of about 73 points, well below normal levels of 125 points. In settlement week, daily volatility is almost guaranteed to rise.

Carryover has been high in percent terms. A healthy 25 per cent of Nifty futures open interest (OI) and 51 per cent of Nifty option OI is in the November series or beyond. However there hasn’t been overall OI expansion. Futures OI dropped week-on-week and option volume and OI was stagnant. This sort of narrow trading pattern never lasts very long and one high-volatility session will most likely be enough to trigger volumes and OI expansion. FIIs hold the key as usual since they collectively hold around 33 per cent of derivatives OI. They have been net sellers through the past two weeks. The domestic institutions have been net sellers for longer, albeit in smaller quantities and DIIs look unlikely to reverse their stance.

Traders and operators lack the depth of pockets to absorb another spate of FII and DII selling. So, if the FIIs stay net-negative, the market is likely to drop into a bearish patch. If the FIIs reverse attitude and start buying, the market is likely to see higher values. Technically, there is good support below current price levels. If the market closes below 4,900, the next reliable support is around 4,750. On the other hand, if the market revives, it could achieve upside targets of 5,300. It is unlikely that the market will swing in both directions inside settlement. It’s set to either stay locked in a narrow range of 4,900-5,100 or it will trend, North or South.

There isn’t much clue about direction available – what there is, is somewhat bullish. Decent carryover is normally associated with bullishness, but then one would also have expected greater volume expansions to place more confidence in this signal. Index futures are mildly favourable. The Nifty and BankNifty are running at small premiums to their respective underlyings and the November series of both are at some premium to October indicating the carryover trend is strong.

The BankNifty has been generating high volumes and OI. Directionally the BankNifty may be due for a bounce. Big banking scrips like SBI and ICICI Bank saw firming up on what looked like a combination of short-covering and investment on last Friday. The CNXIT strongly outperformed the market due to the dollar firming up. If the dollar firms further (to some extent, this depends on FII attitude), the CNXIT will continue to rule high. Put-call ratios (PCR) are in the range of normally bullish. The overall Nifty PCR is at 1.29 with the October ratio at 1.25 and November at 1.3. Put OI (October plus November combined) is clustered between 4,700 and 5,000 with a sharp drop outside this range. Call OI is clustered between 5,000 and 5,300. So traders’ expectations are focussed in that 4,700-5,300 zone. The Nifty is practically on the money at 5,000. If we’re looking at October options, the 5,000c (60) and 5,000p (53) show a difference in premium, which reflects bullish expectations. A long straddle at 5,000 costs 113 with breakevens at 5,113, 4,887. This is expensive and risky with only four sessions to go.

A bullspread of long 5,000c and short 5,100c (20) would cost 40 and pay a maximum of 60. A bearspread of long 5,000p and short 4,900p (22) costs 31 and pays a maximum of 69. Of course, both bearspread and bullspread suffer from expiry risk although the risk-return ratios are good and these are on the money.

It may be tactically better to move away from the money and examine November option positions instead. For example, a long November 5,100c (103) and short 5,200c (64) costs 39 and pays a maximum of 61 while a long November 4,900p (98) and short 4,800p (70) costs 28 and pays a maximum of 72. These are equally good ratios compared to the October CTM spreads. The reduced expiry risk makes them preferable to October positions despite being further from money. Again, the November bearspread has better ratios than the November bullspread, emphasising the bullish expectations.

Long-short straddle combinations are only worth considering in the November series. A long 4,800p and long 5,200c would cost 134. If a short 4,600p (35) and short 5,400c (20) are sold, the net cost is reduced to 79. The breakevens are at 5,279, 4,721 and the maximum return in either direction is 121. The market would need to move around 400 points in November for these to work.

 

STOCK FUTURES/ OPTIONS

There are quite a few interesting stock positions despite the settlement factor, which means traders must stick to the most liquid counters. Note that carryover could open arbitrage opportunities since November series will be at premium to October.

As mentioned above, SBI and ICICI Bank could be worth long positions. Sugar stocks like Bajaj Hindusthan and Shree Renuka Sugars also look bullish. Among metals, Hindalco and Jindal Steel are coming off bottoms and Jindal could be an useful long position. Suzlon is puzzling since it is generating high volumes with little price movement and could make a sudden 10 per cent move in either direction. Among high-volume real estate counters, DLF is moving up, while Unitech and Indiabulls Real Estate are still looking weak and may be worth shorting. However, the clearest short is Larsen & Toubro, which seems to have a target of around Rs 1,530-1,540. Keep a stop loss at Rs 1,590.

 

A CLARIFICATION

In The Smart Investor published on October 19, the second-last paragraph of the 'Derivatives' article read as follows: "Close to money option spreads also have decent risk-reward ratios. A long 5,200c (56) and short 5,300c (24) costs 32 and pays a maximum of 68. A long 5,100p (65) and short 5,000p (38) costs 27 and pays a maximum of 73. Combine the two CTM spreads and the trader stands to lose a maximum of 59 and gain a maximum of 41 on an uni-directional movement. If the market does swing between 5,000-5,300, the trader will gain 82." The last sentence is being clarified as follows: "The position gains on both moves above 5,200 and below 5,100. Between 5,000-5,100, the puts cash out for a maximum return of 41. Between 5,100-5,200, there is no return. Between 5,200-5,300, the calls cash out for 41 maximum. Hence, if both puts and calls cash out, with a movement between 5,000-5,300, the return is 41+41=82."