A big rise is more likely than a big fall.
The F&O segment generated high volumes and Open Interest, which was not surprising given volatile trading with large intra-day ranges. The FIIs cut back on their derivatives exposure and it seemed much of the interest was operator-driven.
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FII outstandings in the derivatives segment saw a decline in aggregate to about 36 per cent of all outstandings from the normal levels of about 40 per cent. This could be due to rumours that Sebi will revisit the P-Note issue in its August 13 meeting.
A large proportion of P-note funds are deployed in derivatives. If there is indeed a further crackdown on PNs, there could be a big loss of F&O volume and by extension, cash volumes, in the short term at least.
Anyway, volumes didn’t suffer last week because local operators took up the slack. So far, August has been a good settlement with plenty of action. It started with extremely high volatility and the VIX at record levels. But the VIX has settled down and, although intra-day ranges remain high, the overall trend has been positive.
Index futures are all trading at premiums to their respective underlyings, which is one of several bullish signals. Even though the settlement has three weeks to run, there is the promise of high carryover if one goes by ample liquidity in September Nifty. There is practically no differential between August and September Nifty contracts which indicates somewhat bullish sentiment.
The hedge ratios, that is, the ratios of volume and OI generated by stock derivatives to the volume and OI generated by index derivatives has risen quite sharply. This is both a sign of increased speculation (because the stock derivative volume is predominantly naked futures) and a sign of increasing bullish confidence.
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The Nifty put-call ratio remains bullish as well. The August PCR in terms of OI is at 1.23 while the overall PCR is at 1.3. Both ratios are well within normal bullish range. Option volume has expanded in all segments.
The bearish signals are less obvious. But there are some. For one, the VIX is still at a pretty high level and that is usually bearish. Also, there has been persistent selling above 4550 Nifty. Third, the lack of institutional support in cash markets is a danger signal – the smart money isn’t strongly committed to this rally.
Fourth, last week’s rally came against the run of inflation as it was led by rate-sensitive stocks such as banks and automobiles. This was despite the WPI climbing to 12 per cent and the RBI hiking repo. One explanation is that markets had already factored in RBI-action and the rise in WPI. But it’s difficult to see a rally being sustained by rate-sensitive counters in this environment.
In a related action, there were global relief rallies because crude remained relatively soft and this undoubtedly had an impact on Indian stocks as well. Crude is still at historically high levels and it’s too early to say if the long-term price trend is moderating.
Our technical perspective would be that the rally is likely to continue because there’s been an upside breakout past Nifty 4,450 on very high volumes. If rate-sensitive stocks drop out, other sectors will sustain it.
But the persistent selling above 4,550 suggests strong resistance, which is confirmed by the presence of massive OI in the call option chain. Similarly, there’s massive support at 4,300 and 4,400 confirmed by the put option chain.
This means most likely, that we continue to see range-trading with moves confined to between 4,300-4,700. If the pattern of the past few sessions continues, the intra-day range will be high. Next week is truncated by Independence Day, which could mean a drop in OI on Thursday. Bear this in mind because it could have an effect on liquidity and lead to higher volatility.
In terms of spreads, a bearspread with long 4500p (124) and short 4,300p (63) costs 61 and pays a maximum of 139. A bullspread of long 4,600c (117) and short 4,800c (44) costs about 73 and pays a maximum of 127. Narrower spreads such as long 4,500p and short 4,400p (89) and long 4,600c and short 4,700c (76) have payoff-cost ratios of 65:35 and 69:41 respectively.
Note that the bullspreads are further from the money but still offer the worse risk-reward ratios. This is a sign of bullish sentiment - it also means that the bearspreads are more tempting. But all the conventional spreads have ratios that are quite acceptable in absolute terms.
A big correction is less likely than a big rise. It may make sense to look at narrower bearspreads if you take a bearish view and to go with wider bullspreads if you take the bullish view. My take is that the long option in both spreads will be struck but the short-options may not be, given a tightly-ranged market.
| STOCK FUTURES/OPTIONS Banks had a great week but the Bank Nifty’s bounce of 8.1 per cent may not be sustainable for reasons mentioned above. Similarly, other bullish finance stocks such HDFC and Reliance Capital may see a slowdown in momentum. Ditto for automobiles. However, shorting these would be bucking the trend. Among engineering stocks, ABB and AIA Eng look good but there’s very little liquidity. |
Chambal Fertiliser (Cash: Rs 81.5) has an interesting profile with high OI in both the stock futures (Rs 82.3) and relatively high OI in the 85c (5.2) and 90c (3.65). It may be worth a long position with a stop loss at Rs 78.