The Nifty has fallen below a key support-resistance level at 2,850 and unable to test it in five subsequent sessions.
Settlement week saw apathetic sentiment and low volumes in a market that refused to make up its mind and move in either direction. Despite the apparent lack of movement, there were some discernible background trends.
Index strategies
FIIs have been net sellers for 10 sessions in succession and that is unusually long. Their exposures in derivatives have spiked to over 41 per cent of all open interest and that may be significantly higher than their average exposures of 37-38 per cent.
The rise in FII exposure coincides with a new settlement. It could be a temporary statistical aberration that corrects as Indian traders get going. But it could also presage a switch in FII attitude to net buyers from net sellers since this signal of rising derivatives exposure before a change in attitude has been noticed a few times. On the other hand, FIIs have tended to be consistent sellers through the early part of recent settlements.
Despite low volumes, the carryover pattern was good. The Bank Nifty already has significant liquidity in the April series and Nifty and CNXIT futures positions have expanded satisfactorily.
The implied volatility has eased down along with the historical volatility and the Vix is lower at 40. The historical volatility (HV) over the past three weeks has been considerably lower than the average HV over the past year.
This is typical of narrow range trading. It makes the subsequent breakout more explosive because volumes and volatility both rise along with the breakout. Traders positioned for range-trading to continue are wrong-footed.
The overall directional signals are bearish or neutral with a few key exceptions. Volumes are low and breadth (advance-declines) is negative. The Nifty has fallen below a key support-resistance level at 2,850 and been unable to test that in five subsequent sessions.
Index futures traded at significant discounts to respective underlyings on Friday. Short-covering ahead of the weekend in the last half-hour was responsible for the cash market’s recovery. Futures discounts could signify bearishness. On Monday, the underlyings and futures will align more closely and it could mean a bigger drop in the cash market rather than a large rise in futures. Incidentally, if the rupee does lose more ground, a long CNXIT looks almost as good a hedge as a long USD.
The put-call ratio is bullish. About 66 per cent of Nifty option open interest (OI) is in March and the near-month PCR in terms of OI is at 1.7, which is quite bullish. The overall PCR (in terms of OI) is at 1.4, which is also bullish.
The Bank Nifty looked very strong on Friday afternoon when there was a spate of buying that was concentrated in bigger PSU banks. This could be short-covering but it smelled like a correction in a sector that has underperformed the market in the past two weeks. A long Bank Nifty looks a definite possibility.
The Bank Nifty has significant weight and influence on the Nifty and if it does move up, the market could also bounce. Apart from this, there is the FII factor. As mentioned above, if the selling run reverses, it could be enough to push up the market.
Option traders can take several attitudes in the new settlement. One is to assume the range trading will continue indefinitely. Another is to align positions in anticipation of a specific directional breakout, up or down. A third possibility is to cover both breakouts.
Assuming the range trading will continue is against the odds. The Nifty’s long-term HV suggests that it is unlikely to be the case beyond 5-10 sessions. It is also a dangerous attitude to take since the losses on writing far-from-money puts and calls could be heavy. In general, a low implied volatility (IV), low-premium situation like the current one suggests option buying strategies.
Going with a specific directional breakout before it happens has obvious risks. Managing positions that cover both possibilities of directional breakout seems more prudent.
Traders could therefore, consider long-short strangles. The breakout, as and when it comes, will mean a move of 200-250 points away from the current 2,700-2,800 range. A long 2,600p (66.5) and a long 2,900c (43) could be combined with short 2,400p (29.5) and short 3,100c (9.5) for a net cost of 71 and potential maximum payoffs of 129 on either side. This has a breakeven at 2,529 and 2,971. A narrower position with a short 2,500p (45) and a short 3,000c (20) costs a net 45 and pays a maximum 55 and this also seems reasonable.
A close-to-money bullspread with long 2,800c (81.5) and short 2,900c (43) costs 38.5 and pays a maximum of 61.5. A CTM bearspread of long 2,700p (99) and short 2,600p (66.5) costs 32.5 and pays a maximum of 67.5. Both have good risk-reward ratios and you can make a case for taking either.
| STOCK FUTURES/ OPTIONS This is a market with very scattered stock trends. The majority are down but there are potential winners visible in most sectors as well. Cement appears to be the one sector that is seeing massive disinvestment so shorts in Grasim or Ambuja could work. |
