Excellent risk-reward ratios due to expiry effect
The market made a breakout that propelled it to new highs. Volumes and open interest (OI) zoomed ahead of the December settlement.
Index Strategies
2010 could be ushered in amidst bullish enthusiasm. The breach of resistance at 5,180 was accompanied by huge volume expansions in cash and derivatives. There are very few sessions left till settlement (December 31).
The FIIs made surprising commitments becoming net buyers at a point when they are closing books. This could be short-covering or rebalancing, but it had a strongly bullish impact since Indian operators built on the FII buys.
Assuming the FIIs don't immediately reverse attitude, the settlement should end high. The technical picture looks good, with targets in the range of 5,300. Volatility has risen along with the breakout and given holidays, there could be abnormally high daily swings.
The holiday factor also means sharper expiry effects. Even close-to-money December premiums have dropped. However, the open interest trend is good and the carryover pattern is excellent.
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About 60 per cent of Nifty Option OI and 35 per cent of Nifty futures OI is in January or beyond.
There has also been significant expansion in volumes and OI in the CNXIT and Bank Nifty. In fact, the CNXIT is generating multiples of its historic OI and there is good carryover into January. The focus on the CNXIT has arisen from its excellent performance through 2009. However, the rupee looks to be strengthening and next week, the CNXIT may underperform as a result.
The Bank Nifty is recovering after several weeks of underperformance. This appears to be a technical correction after the market discounted the impact of a likely rise in interest rates. The NSE interest rate futures have seen rising yields and so have recent T-Bill auctions. In the longer run, the Bank Nifty could run into sell offs. But, the OI patterns suggest that short-covering in the bigger financial sector players hasn't ended. So, this week, a long Bank Nifty position may just pay off.
The Nifty has several levels of clear support and resistance. On the upside, resistance between 5,170 and 5,200 has not been completely broken. If it is, the index will have a clear run till 5,300. On the downside, there is support at 5,050-5,075 and lower down, at 4,950-5,000. It is possible that we will see the Nifty range through 4,900-5,300. Given the trading trends, we'd expect net gains.
The option trader can do several things. One is to stick to December instruments and look to exploit the expiry factor and the unusually good risk-reward ratios it is throwing up. Don't sell naked options – the volatility is too likely to be high. Using December instruments does of course, leave one exposed to expiry risks.
The second possibility is to take positions using January options, which are already quite liquid. Here, the risk-reward ratios close to money are quite acceptable. If you are interested in strangles far from money, going with January instruments may be the best strategy since that reduces the expiry risk considerably.
An examination of the December Option chains gives us a better idea of short-term expectations. In the put chain, the maximum OI is at 5,000p (7) with plenty of liquidity also visible at 4,800p (2.5), 4,900p (4), and 5,100p (17) as well as 5,200p (48). In value terms, the 5,100p and 5,200p dominate.
In the call chain, the 5,200c (39) dominates in terms of OI with liquidity visible at 5,100c (104) and 5,300c (9) as well. In value terms, if we ignore some long-term in-the-money holdings at 3,600c and 3,800c, the major value is at the 5,000c (192) mark. As we can see, OI and expectations are focussed between 4,800 and 5,400.
In terms of CTM bullspreads, the long December 5,200c and short 5,300c costs a net 30 and pays a maximum 70. The equivalent CTM bearspread of long December 5,100p and short December 5,000p costs a net 10 and pays a maximum 90. Even allowing for expiry risk these are extremely good risk-return ratios. You could combine these two CTM spreads for a long-short strangle position that costs a net 40 and pays a maximum 60 if the market touches either of 5,000 or 5,300. If it hits both ends of this trading range, the return would be close to 160.
If you are looking for wider positions, consider the January bullspread of long 5,300c (84) and short 5,400c (48), which costs a net 36 and pays a maximum of 64. The January bearspread of long 5,000p (68) and short 4,900p (47) costs 21 and pays a maximum of 79. A long strangle of long 5,000p and long 5,300c offset by a short strangle of 4,800p (32) and 5,600c (14) costs a net 106 and pays a maximum 94 on a one-sided move that touches either 5,600 or 4,800. This is reasonable and this combination is likely to be cheaper by December 31.
| STOCK FUTURES/ OPTIONS The stock market is seeing a situation where a host of highly liquid F&O counters are close to their 2009 highs or already at that point. There are very few stocks that offer reasonable looking shorts at the current moment. The telecom sector could be one possibility for the bearish. Idea and Airtel are both in correction mode. Any of the high-weighted bank counters like SBI or ICICI Bank could yield good long positions. In the IT sector, Educomp could zoom. Among other stocks, a long position in IDFC or Tata Steel may pay off. But, the most tempting seems Tata Motors, which is in a strong bull-run and hitting successive highs. |