Bearish signals

The downwards drift could worsen to a full-scale downside breakout.

The lead in to the January settlement week was a low volume and bearish affair with week when prices slid down. Volumes and open interest patterns are depressing.

Index strategies

Intraday volatility dropped in the past few sessions but the price trend was negative last week. The settlement week is certain to inject a little volatility in terms of wider daily range. It is also likely to make a positive, if temporary difference, to volumes in the next three sessions.

Both Indian traders and FIIs have cut back on derivative exposures. Volumes have been low and so is open interest (OI). FIIs hold 35 per cent of all OI, which is lower in both absolute and percentage terms than their normal commitments.

Index carryover is average. About 40 per cent of Nifty futures OI has moved to February and March. The BankNifty has around 30 per cent of OI in February. There isn't much liquidity in the CNXIT, and no carryover to February yet. All the traded futures were settled on Friday at significant discount to their underlyings indicating bearish sentiment.

There was some evidence of short covering on Friday and this could push up levels in individual stocks as well as in Nifty and BankNifty futures. However, the hedge ratio of index positions to all positions (stock and index) is high which suggests that there will not be a great deal of stock futures carryover into February.

Trading in stock futures is likely to be heavily concentrated on a few high-volume counters. It's likely that traders will only come in some two or three sessions into the February settlement after extinguishing January stock futures positions without carryover.

Volatility is almost guaranteed to rise. The VIX is not a very useful indicator at this stage of settlement but it has dropped to around 34 from levels of over 50 two weeks ago. That seems very low, given bearish trends and settlement. Expect at least one of the three settlement sessions to be a "150-pointer".

This leads to interesting technical conclusions. If you suddenly inject higher volumes and higher volatility into a market, prices tend to breakout from previous trading ranges. The downwards drift could be accentuated into a full-scale downside breakout. This seems more likely than a sudden upside breakout.

The key levels to watch are support at 2,500-2,550 and resistance at 2,850-2,900. If the market can swing outside either of these, a new trend will be established. If it does swing on higher volume, which is likely on settlement, the breakout would be powerful.

Purely on chart patterns, a close outside the 2,500-2,900 zone would lead to projections of a further move of 300-odd points in the direction of breakout.

For an upside, genuine buying power in terms of cash inflows is required. The downside requires either fresh supplies of stocks or further short sales. The downside breakout appears a more realistic possibility. It is also possible that the market will continue to oscillate between 2,500-2,900 with a downside bias, testing the floor more often than the ceiling.

Apart from bearish signals like low volumes, poor breadth and low OI, index options also show bearish characteristics. Over 28 lakh options (combined) have been extinguished. The Nifty PCR (in terms of OI) is down to an exceedingly bearish 0.8 overall and the January PCR is down to a frightening 0.66 with February onwards at PCR of 0.95, which is, in itself, bearish. About 43 per cent of option OI is now in mid and far month contracts.

The expiry risk is higher than normal with only three sessions to go. Despite extremely decent risk-reward ratios in close-to-money premiums, it may be prudent for traders to consider staying out of January series and moving directly to February. Alternatively, stay out of the market until post-settlement because the February option chain will not be fully liquid until then. Or use straddle-strangle combinations rather than one-way spreads.

In the Jan series, a long 2,700c (27) and a short 2,800c (6) costs a net 21 and offers a potentially maximum return of 79. A Jan bearspread with long 2,600p (27) and short 2,500p (7) costs a net 20 and offers a maximum return of 80.

It is likely that one of these will be struck and it's not impossible that both will be. If you combine the two positions, you create a long strangle of long 2,600p and long 2,700c, laid off by a short strangle of short 2,500p and short 2,800c. That costs a net 41 and pays a net 59 with breakevens at 2,559 and 2,741. This is reasonable and it may work within the next three sessions.

Using February options, a long 2,700c (134) and a short 2,800c (88) costs a net 46 and pays a maximum of 54. A long 2,600p (137) and a short 2,500p (102) costs 35 and pays a maximum of 65. The risk-reward ratios are reasonable, given mitigation of expiry risk. The bearspread especially may be worth taking.

 

STOCK FUTURES/ OPTIONS

There are a plethora of stocks that have smashed previous supports. Banks and real estate scrips lead that race to the bottom. Some other stocks have hit support levels and may just bounce on short covering. One risky but tempting long position is Educomp.

The stock has taken an awful hammering with all sorts of rumours, allegations and counter allegations floating around. It may be ripe for a bounce. Keep a stop at around Rs 1700-Rs 1710 and go long with a three-session target of Rs 1,900.