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Bearish signals across indices

DERIVATIVES

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Devangshu Datta New Delhi
Last Updated : Feb 05 2013 | 3:21 AM IST
As spot prices dip sharply and arbitrage opportunities turn fewer, the best a trader can do is stay short.
 
The derivatives market continued to exhibit a dangerous combination of low volumes and high volatility leading to a rise in the implied volatility of option premiums. The FIIs continue to hold a disproportionate share of the outstandings in the lacklustre market with over 45 per cent of all open interest.
 
Index strategies
The FIIs clearly hold the key and their attitude changed in the early part of the week with a lot of buying in the cash segment on Monday and Tuesday. However, they were net sellers again in the last three sessions of the week. The bulk of Indian operator money appears to have moved out as traders hit by the gyrations of the past month are still licking their wounds.
 
The Nifty continues to swing by over 3 per cent per session, which means that day traders must reckon with 150-200 point moves. Volumes have started to concentrate in the index derivatives with the smaller F&O stocks all losing liquidity. In this situation, where even overnight positions may be dangerous, very few traders are prepared to even investigate the possibilities of the far-term and mid-term futures.
 
All the other indices had negligible liquidity in the mid or far term futures. Most were trading at discounts to the spot rates, which does suggest the short-term sentiment remains bearish.
 
The spot Nifty closed at 5,120 while the Feb Nifty futures was settled at 5,090 and the March and April series at 5,086 and 5,082 respectively. Open interest expanded across all three series but April open interest was not much in absolute terms. The differential between the spot and near-term was exceedingly high. But there are no calendar trades available with the current differentials between the futures' series. The MiniNifty was settled at 5,091 (Feb), 5,087(Mar) and 5,100 (April) with very little open interest except in the near month.
 
The Junior closed at 9,740 in spot and it was settled at 9,706 in the near-term futures. A few contracts were cashed out leading to a small reduction in near-term open interest. The Bank Nifty closed at 8,817 in spot and it was settled at 8,814.6 near-term with a few contracts in the March futures at 8,952.35. The CNXIT closed at 3,961 and it was settled at 3,926. The Midcaps closed at 2,796.80 with the Feb contract settled at 2,809.
 
While the signals in terms of discounts are bearish, the differential between spot and future is likely to narrow as and when spot prices dip sharply. Unfortunately there isn't any way to pick up an arbitrage. The best a trader can do is stay short. In the BankNifty, the near-term versus mid-term difference can be arbitraged with a calendar spread of long Feb and short March.
 
In the Nifty options market, premiums are unsurprisingly high, given the extreme volatility we have experienced. The put-call ratio is at 0.95, which is quite bearish. Both put and call open interest has been expanding. One blessing is that there is lots of liquidity above and below the money.
 
A bull spread with long 5,200c (208.5) versus short 5,300c (166) costs 43 and pays a maximum of 57. A bear spread with long 5,000p (226.7) and short 4,900p (181) costs 45 and pays a maximum of 55. There isn't much difference between the risk-reward ratios so you may as well take the bear spread, given the many bearish signals. However, the excessive volatility has manifested in wild spikes in premium and option pricing could change significantly on Monday.
 
A far from money straddle such as long 4,800p (143) and long 5,400c (126) costs 269 and breaks even if the market moves beyond 4,530-5,670. This could be struck if there is a breakout from the current trading range.
 
However it is very expensive. Closer to money straddles such as long 5,200c and long 5,000p will cost about 435. If these are laid off with the short 4,800p and short 5,400c, the net cost would be about 165. The resulting position would breakeven if the market moved beyond 4,835-5,365. However, the pay off is too small to make this worth it.
 
On balance, the signals suggest the market will fall. The close-to-money bear spreads have marginally worse ratios than the bull spreads. So it probably makes sense to take the bear spreads. However it is possible to make a contrarian case for the bull s with the Budget around the corner. If PC can talk the market up in his usual style, a bounce within the settlement is also quite likely.
 
Stock Futures / Options
 
Most stocks are range-trading with a slightly bearish bias. Liquidity has dropped except in the most highly-traded 30 stock futures contracts. Volatility is quite high with IV in contracts such as Essar Oil running at the 200 per cent per annum mark.
 
Apart from the Reliance and ADA counters, Jindal Steel, NTPC and Essar Oil are among the most heavily traded at the moment. None of these have a clear trend "� most have lost ground but are resting on reasonable looking supports. If we're right about the bearish feel to the indices, it would be logical to assume that those supports could break.
 
Ideally one would use short futures, long call combinations with the call as a hedge while the short future is the primary position. However, except for RIL, there isn't adequate option liquidity to do this. If you short RIL at 2,426 (spot: 2,426) and take a long call at 2,600 (55), you could lose a maximum of 230 and hope to gain about the same. Otherwise, short Reliance Capital as the weakest looking of the actively traded counters.

 

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First Published: Feb 11 2008 | 12:00 AM IST

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