Yet another low volatility, low-volume week passed. But an important signal was the market scaling a new high
Index strategies Several weeks of low volatility has left traders comfortable with overnight positions. So open interest (OI) has climbed despite low daily trading volumes. FIIs hold around 36 per cent of OI. The new high confirms that the major trend is still bullish but the intermediate and short-term trends may be weak.
An absence of strong volume action and average breadth suggests that a downturn is not unlikely. The time factor also favours a trend reversal. The intermediate trend has been up for more than two months and it usually matures between 7-12 weeks.
Historically, March-April is a high-volatility period. There is the Budget, there are full-year results and advisories, there are liquidity pressures due to tax payments and there’s the RBI policy. This year has been unusually calm. Post-Budget, FIIs have bought and domestic investors (institutions as well as retail) have sold just enough to balance off. An alignment in institutional attitude in either direction is required for the market to move significantly. If there isn’t much change in volume or volatility, the market will range-trade between 5,200-5,350.
A breakout in either direction should lead to more volumes coming into play and a jump in volatility. It will happen sooner or later. If one looks at prices and ignores poor volume signals, a case could be made for an upside target of about 5,450. The bulls will point to the fact that OI is growing, put-call ratios remain in the normal– bullish range and traded index futures are all running at premium to their respective underlyings.
If we place greater weight on poor background signals and time factor, a downside breakout looks more likely. If an intermediate trend reversal occurs immediately (in the next 5 sessions) it could push the market down till the 4,800 mark within the settlement (April 29).
Clearly, this is a bearish view and it may be incorrect or over-pessimistic. There’s lots of support on the downside and even in a downtrend, we’d expect support to be tested at 5,150-5,200 and again at 5,050-5,100 and so on.
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One reason for bearishness is the rise of the rupee versus the dollar. This has already had an adverse impact on the IT sector with the CNXIT underperforming. Analysts are assuming 2010-11 advisories will not be very strong. We’ll know soon enough since results are around the corner. The Bank Nifty has been mildly positive but again, the April RBI policy is not expected to be favourable. If these two key sectors aren’t overtly bullish, the Nifty is unlikely to move up by a huge amount.
Traders should target a "core range" of 5,200-5,400 and they should be braced for a move up till around 5,500. On the downside, the possible movement could be substantially more but there’s support at roughly 50 point intervals below 5,200.
The April option chains show that market expectations are indeed, factoring in a larger downside. The put chain has good OI starting at 5,300p ( premium:90) with a spike at 5,200p (55) and substantial OI all the way to 4,800p (7), via 4,900p (11), 5,000p (20) and 5,100p (33). The call chain has some OI at 5,200c (159) good OI at 5,300c (96) and maximum OI at 5,400c (48) with some OI at 5,500c (19).
In effect, the 5,300c and 5,300p are on the money with the Nifty settled at 5,307 and the underlying closing at 5,290. A long 5,300c and short 5,400c costs 48 and pays a maximum of 52 while a long 5,300p and short 5,200p costs 35 and pays a maximum 65. Further from money, a long 5,400c and a short 5,500c costs 29 and pays a maximum of 71 while a long 5,200p and short 5,100p costs 22 and pays a maximum 78. Bullspreads should therefore be taken away from money but you could also take a bearspread on the money.
A long straddle at 5,300 would cost 186 and it could be laid off with a short 5,500c and short 5,100p for a net cost of 134. This is expensive with breakevens at 5,166 and 5,434 and a maximum return of 66. A long-short strangle with long 5,400c, long 5,200p and short 5,500c and short 5,100p costs 51. The risk-reward ratio is almost 1:1 with breakevens at 5,149 and 5,451 and a maximum one-way return of 49.
If you don’t think the market will move much and it will have a downside bias, consider a long put butterfly, with a long 5,300p, two short 5,200p and a long 5,100p. Even with commissions, this is cheap since it costs around 12 (without commissions). That’s the maximum loss, at 5,100 and 5,300. The maximum gain is about 88 at 5,200 and the breakevens are at 5,112 and 5,288.
| STOCK FUTURES/ OPTIONS The stock segment remains difficult to trade with any degree of certainty. Trends have been cycling up and down in various sectors within a couple of sessions. This choppiness could persist until there's some clarity on FY 2009-10 results. That means wide stop losses, and extra margins, if you are in the futures market. Among the usual suspects, IT majors still seem bearish. Metals seem mildly bullish. Real estate is a toss-up with trends switching on a daily basis. Renuka may be due for an upmove. Mundra Port is one of the more unusual plays in stock futures section with higher volumes and volatility than normal. It is attracting institutional attention and may be worth a long position at current prices. Tata Steel offers a reasonable option bullspread of long 660c (18) and short 680c (10.5) which will cost about 7.5 and pay a maximum of 12.5. |