Expect volatility to ease off

June starts off with a nervous market, but the worst phase of the sell-off appears to be over.

The end of a derivative settlement marked by unusual turmoil would have led to sighs of relief all round the trading and investing community. The first four sessions of this week were dominated by arbitrage considerations.

Many stock futures were trading at discounts to their spot prices. This led to sequences where traders sold the stock and bought the futures, reversing their trades later to lock in the differential in spreads. June starts off with a nervous market, but the worst phase of the sell-off appears to be over.

Index strategies: Towards the end of the May settlement, OI had dropped alarmingly and the put-call ratio had dropped below one as well.

This suggested that the derivatives market was becoming overbought and, indeed, that was confirmed by the action between May 22 and May 25 when there was major selling across the spot market coupled to the build-up of large call-based and futures positions.

The June settlement has started with a further erosion of OI in the Nifty futures segment. With the spot Nifty closing at 3,209, the June Nifty future is trading at 3,179, July is trading at 3,164.85 and August Nifty is trading at 3,172, though there is hardly any liquidity in the August series.

The substantial discount indicates that the consensus about the short-term trend is bearish. We could take a calendar bear-spread of short June Nifty and long July Nifty. This basis play should lock in the 15-point differential assuming that the spread narrows. It's early in the settlement, however.

In the options market, there has been a substantial increase in OI of Nifty options in both call and put segments. On Friday, the put-call ratio in the Nifty June options segment reached about 0.79, which is higher than in the last four or five sessions.

In the context of the bull market, it is, however, still unusually low. This suggests that the options segment continues to be somewhat overbought and that could mean another drop in the spot market.

In technical terms, on account of the commencement of a new settlement, we would expect volatility to ease off from previous levels of over 5 per cent to around more normal levels of 2-3 per cent. We would expect the Nifty to move between 3,100 and 3,350 in the next week with a slight upwards bias. If 3,100 is broken, a drop till the 2,900 level is, however, possible.

A standard bull-spread with long 3250c (107) versus short 3300c (89) costs about 18 and pays a maximum of 32. A standard bear-spread of long 3150p (123.5) versus short 3100p (103.5) costs 20 and pays a maximum of 30.

Both are positions with attractive risk:reward ratios, adequate liquidity and fair chances of being struck inside the week and certainly inside the settlement.

Straddles and strangles appear too expensive for comfort. We may however consider a wide bearspread of long 3100p (104) and short 3000p (68). This costs 36 and pays a maximum of 64. There's a very good chance of it being struck inside the settlement.

In the case of the other tradeable options, the Banknifty spot value is 4324, while the June BankNifty series is at 4328.95. The CNX IT is trading at 3977.2 in spot, while the June series is at 3950. My perspective would be to sell the Banknifty and buy the CNX IT given rupee weakness and the trend of rising interest rates.

There is a margin of safety in the CNXIT given the reasonably substantial discount in the future's price. But the Banknifty is a purely technical play that could lose in a fairly large way if there's a bounce across the entire market.

Both these would effectively be unhedged positions so, there's a significant margin outgo.

STOCK FUTURES/ OPTIONS

There is likely to be a large loss of volume in the futures market. This is where the largest share of speculative activity was concentrated and most of those traders have pulled out in order to lick their wounds. The stock options segment is also under-populated and short on OI.

It's too early in the settlement to start playing arbitrages between futures and spot prices. While many counters are running at discounts in the futures segment, it's four weeks till expiry. After taking execution errors and brokerage into account, it's not worth the annualised gains at this stage.

On the buy side, there are very few stocks that promise to outperform the market. You could take long positions in the June series of ACC, Dabur, and perhaps in HPCL and BPCL given that another petrol price hike now seems imminent.

Reliance Petro appears to have weathered the initial stage of listing and bottomed after several sessions of trading at huge premiums with large volumes. It may be worth buying with a perspective of holding till the end of the settlement. The futures (69.95) is at a discount to the spot (71.2).

I've been eagerly tracking the IT majors in the hope of a large technical bounce. The rupee weakening could be one trigger. The other is simple liquidity and market correlation.

Infosys, TCS, Wipro, Satyam; all tend to move with the market but they are also all high-beta stocks that generally beat the indices. Right now, there's no obvious bullishness apparent across these four scrips however.

Hence, the suggestion that we take a long CNX IT position rather than dabble in these stock-specific positions.