Delivery sales could outrun short covering.
A massive fall before a truncated settlement week promises that the next three sessions will be very interesting. Expect wild prices swings and huge volumes across the F&O universe. Carryover will be concentrated in the indices.
Index strategies
The price direction is difficult to call but we can predict some general characteristics with greater confidence. Expect huge volumes. A lot of traders will be closing out positions and going on vacation. Expect open interest (OI) to fall despite high volumes. Expect high intra-day volatility – 250-300 points moves are likely. Both IV as indicated by the VIX and historical volatility are high. Hedge ratios are high. A large share of early November open interest will centre on the Nifty.
The carryover in index futures has been strong with 45 per cent of Nifty futures open interest already in November and December series. Given that the hedge ratios are high, massive volumes could move into Nifty November (2546) and out of October (2560).
The differential will correct in favour of November with arbitrageurs also getting active. Try a calendar spread starting long November Nifty and short October Nifty. This can be reversed if November goes into premium (a 20 point premium is possible – meaning 33 points profit).
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The November BankNifty (4309) could also appreciate significantly with respect to the October series (4288) – November is already at premium. There is a lot of short interest in the BankNifty, which lost 16 per cent last week. That short interest will be dissolved with covering and the November BankNifty should pick up 3-4 lakhs OI in the next 3-4 sessions. This could make a long November BankNifty profitable. Keep a stop at 4250 if you take this trade.
The CNXIT is puzzling. The sector has been buoyed by the weak rupee, which in turn has been held down by FII selling (around $13 billion for 2008). Will the RBI intervene? It has already expended $30 billion in rupee support. Will the FIIs continue selling against delivery? If they do, the rupee will stay down and a long CNXIT could be a hedge against a falling market. But if the rupee bounces, the CNXIT will lose ground and a short will be profitable.
FII intentions have interesting implications in the settlement week that go beyond rupee direction affecting the IT sector. On one side, there is short interest (Indian traders as well as FIIs) in the F&O segment, which must dissolve or carryover. Either way, short covering could pull up the Nifty. A zoom till 3050 would be possible if there is short covering without attracting fresh sales against delivery in the cash market.
However, there is also the possibility of FII sales against delivery and there are outstanding FII sales against stock-lending. The Finance Minister is trying to talk the short sellers into squaring off. If he succeeds, that’s another short-covering component with a temporary bullish effect.
When it comes to sales against delivery, the FIIs are the biggest players by far. If they sell large volumes into a rally driven by short-covering, the market may fall despite settlement considerations. Essentially deliver sales may overwhelm short covering purchases. This is difficult to make a definitive judgment about but it’s certainly a possible scenario. I think that sales against delivery would occur above 2850 but it could come earlier or later.
Taking the above together, this means a rally would terminate around 3050 maximum and more likely between 2850-2950. On the downside, there is support at current levels and down till around 2400. That’s on chart patterns. If we look at option breakevens, the put OI patterns suggest most expectations of breakevens are focussed at the 2330-2430 range while call OI patterns suggest that most breakeven expectations are 3125 upwards.
The option chains, the put chain in particular, are almost useless to traders because the nearest strikes are in the range of 2750p and 2750c. The market fell too fast on Friday.
It’s possible to construct cheap bullspreads with say, long 2800c (38.45) and short 2900c (21.95) but expiry is a serious threat despite the decent risk reward ratio of a cost of 16.5 and maximum gain of 83.5. There’s no sense in attempting normal bearspreads – the nearest strike of long 2750p (237.6) is prohibitively expensive and well in the money. Presumably the 2600p and 2500p will open on Monday but no guesses on the premiums is possible given expiry threat.
You can sell the 2900c (21.95) and buy the 3000c (12.25) to create a reversed bearspread. The position has an inflow of about 9 and a terrible risk:reward ratio with a potential loss of 91. Alternatively sell the 3000c and buy the 3200p (4.5) – this is less likely to be struck since it’s further from the money and it should expire with a profit of 8.
| STOCK FUTURES/OPTIONS There is a huge scope for taking both short stock futures positions as well as trying to exploit short-covering by taking long positions. Stick to the top 20-30 counters in terms of volumes because of liquidity considerations. Be prepared for the fact the OI may contract sharply along with violent price swings. Interesting shorts include PNB, Suzlon, Sail, HUL and RPL. If you go short, keep a stop at about 5 per cent from Friday’s last traded price. Reliance and NTPC could offer potentially lucrative long positions. Keep a stop about 3 per cent from the Friday last traded price. |