The National Stock Exchange's Nifty, with its highly liquid futures and options can be traded conveniently in either direction. A trader will buy the futures when he thinks other people are buying and sell if he thinks the index is likely to go down. Trader index-positions are built on individual expectations of direction and volatility. But the aggregate does indicate a consensus on how much the index is expected to swing, and in which direction.
This is even more visible in index option positions, where biases can be easily seen. Unlike a buy/sell or a futures trade, where there is always a counter-party, there is usually a preponderance of either calls or puts in the market.
The put call ratio (PCR) is one data-set that can indicate if expectations are bullish or bearish. The assessment is paradoxical at first glance. A PCR of 1 or so (where the open interest is roughly equal in puts and calls) is taken to be "neutral". A high PCR of say, more than 1.1 (where puts exceed calls by 10 per cent or more) is generally considered bullish. The logic is, hedgers long in the index futures, or with stock positions to protect, will take puts.
A low PCR of less than 0.9 (where calls exceed puts by 10 per cent or more) is considered bearish. The logic is similar but inverted. It is assumed traders who have shorted the index futures are hedging positions with long calls.
Another data set is open interest (OI) accumulated at various strikes on the option chains. If there is heavy open interest at a given strike, a lot of traders think strike could be hit. We can get a sense of expectations by looking at OI in puts and calls at some distance from the money.
All these interpretations have to be applied with some caution. There will be special circumstances. Expiry considerations for instance, can lead to bursts of short covering, or extinguishing of overhanging long positions that make interpretations of PCR unreliable. In periods when results are being declared, the broad index could be influenced by the result flow leading to volatility caused by specific stocks, as their results are declared.
In the Indian context, calls are generally priced higher than puts at the same distance from money. Right now, the PCR is hovering above 1.1, indicating the mood is mildly bullish.
There is a lot of OI in the May 8,800c and similarly, a lot of OI in the May 8,000p, and also high OI in every strike in-between 8,000 and 8,800. The index is placed close to 8,400, which means traders are braced for a five per cent move in either direction by May 28. That is, within the next seven sessions.
The index moved a lot in the first half of May, hitting a low of 7,997 and a high of 8,427. It is into expiry mode now, which means rapid erosion of premium. It would take two big sessions trending in the same direction, to bring either 8,000 or 8,800 anywhere within reach.
Session by session, far from money options will become cheaper. The probability of a big move will also decline. The odds are: volatility will stay high through till settlement. But the index looks likely to stay within the range of 8,150-8,550.
The trader has an interesting choice. He could buy cheap options at some distance from money, which will pay handsomely if struck. Or he could sell very cheap options far from money, hoping to keep the premium if those expire without being hit. Direction is hard to judge since May has been very choppy.
The author is a technical and equity analyst
