Trading focus on the near-term

A northwards breakout early in the week was followed by a correction. Open interest (OI) continued to expand though it was concentrated in the December series.

The Nifty tested its 2009 high of 5,181 (first reached on October 20) and immediately pulled back. It held on support at around 5,075. Trading volumes were on the lower side of average and hedge ratios rose. OI continued to expand.

Normally, around 60 per cent of Nifty option OI tends to be focussed on the near-term while the rest is spread across the other series. In this instance, around 72 per cent of OI is in December, which suggests a very strong near-term focus.

 

One possible explanation is that FIIs and hedge funds which close their fiscal year in December have not taken forward positions. However FIIs hold only about 36 per cent of the total OI so that can’t account fully for the December focus.

Directional signals are contradictory. The double-top is bearish and so is the lack of volumes. So is the rising hedge ratio. However, the intermediate trend looks to be up as is the long-term trend. The put-call ratios (PCR) are in positive zones. The Vix is down, which is again a positive sentiment indicator.

All traded index futures are running at small premiums to their underlyings and all saw increased liquidity in terms of both volumes as well as OI. In general, OI is up, which is another positive signal. The Bank Nifty appears to have started a correction while the trend is mixed in the CNXIT. A stronger rupee could put pressure on the IT sector.

One interpretation is that this ongoing short-term correction will be shallow with bounces from support at 5,000-5,050 and it will be followed by another test of the 2009 highs, perhaps with a breakout. Another possibility is that the market will slide into range-trading between 4,800-5,000. Either of these seems fairly consistent with current data.

The third possibility is a sharp down move. This is possible if FIIs withdraw from the market in late December as they have sometimes done. In that case, the market could slide till around 4,500. A lot of operator volume seems focussed on hedging that situation, which explains the OI buildup in December. If carryover doesn’t pick-up, volumes would also drop in late December.

Traders with a very short-term focus should be looking at the 4,800-5,200 range, while traders with the timeframe of the December settlement should be concerned about the wider range of 4,500-5,400. There is a good chance volatility will climb if there’s a breakout below 5,000 or of course, if the market does clear 5,181.

The Nifty PCR (in terms of OI) is in normal bullish territory with the overall ratio at 1.4 and the December series PCR at 1.6. OI across the put and call options chains appears to be distributed as one would expect with higher clusters closer to money.

The call chain is entirely normal with the maximum OI at December 5,200c (85) with other heavy concentrations at 5,100c (134), 5,300c (48) and 5,400c (24). There is a sharp drop in call OI beyond 5,400 so that appears the limit of trader expectation. The put chain has maximum OI at December 5,000p (82) and then at 4,900p (57), 4,800p (39) and 5,100p (118). However, there’s also significant OI at 4,500p (13). That suggests pessimists are braced for a possible fall till that level.

Close-to-money (CTM) spreads are offering very decent risk-reward ratios. The bullspread with long 5,200c and short 5,300c costs 37 and pays a maximum of 63. The CTM bearspread of long 5,100p and short 5,000p costs 36 and pays 64. The bearpsread is almost on the money and if we move away to a long 5,000p and short 4,900p, the return rises to a maximum of 75 with a cost of 25.

A long straddle at 5,100 could cost around 252, which is too expensive for comfort. A long strangle of long 4,900p and long 5,300c looks more reasonable. This costs 105 and it can be laid off with a short 5,400c and short 4,800p to reduce the total cost to about 42. This is reasonable since the long-short strangle combination breaks even at 5,342, 4,858 and offers a return of about 58 if the market moves to either limit. There is just a chance that we may see a move touching both 4,800 and 5,400. In that case, the return could shoot up to around 158.

The other tempting position given the put option chain is a far from money bearspread at long 4,600p (18) and short 4,500p (13). This costs just 5 and may pay a maximum 95 if the pessimistic expectations are fulfilled. Even otherwise, if there is a down move, there would be a profit since the 4,600p premium would rise faster than the 4,500p premium.
 

STOCK FUTURES/OPTIONS

The stock derivatives market presents a fairly mixed picture in sector terms. Banks and real estate counters seem to have begun sector-wise corrections, so, shorts would be available in high-volume futures such as Unitech or SBI. Several pharma counters are also seeing a secular rise. Other sectors have almost equal numbers of uptrending stocks versus downtrending stocks. 

One of the more interesting possibilities is a long position in Idea, or RCom. Jindal Steel also looks like a potential long position. An even more attractive long position appears to be Biocon, which has seen a sharp rise in the recent past. Keep a stop at around Rs 285.