Expect a carryover stampede

Indicators suggest a bearish trend amidst high volumes and massive volatility.

Going into settlement week, we see higher daily volumes, massive volatility, and a dangerously overbought Nifty put-call ratio. When you factor the shortened week, there could also be a carryover traffic jam in the next four sessions.

Index strategies
Given expectations of high volatility and falling prices, the derivatives market usually sees action. Indeed, trading volumes have improved in the past fortnight, though cash trading volumes have fallen. FIIs continue to be the market-makers since they hold around 44 per cent of open positions.

There is low open interest overall and high open interest focus on the Nifty. The carryover situation is very interesting.

As of Wednesday March 19, less than 20 per cent of all open positions were in April contracts and beyond. The weekend before settlement, that ratio is often closer to 30 per cent.

We may therefore see a sharper-than-normal expansion in April contracts probably coupled with massive extinction of March positions. This could cause unpredictable intra-day swings that infect the cash market.

Obviously, arbitrage opportunities will come through momentary imperfections. As of now, most underlying indices are at premiums to March futures. The only exception is the CNX IT. However, apart from the Nifty, there is very little liquidity.

For what it's worth, the cash Nifty closed at 4,573.95, while the March, April and May contracts were held at 4,572.70, 4,552.90 and 4,534.45, respectively.

Some 24 lakh contracts were extinguished in March, while 18 lakh new contracts opened in April and May combined. Despite full margins, a long April, short March (or a long May, short April) calendar spread may work. Most of the market will be heading this way.

Among other indices, the best liquidity is in the Bank Nifty, where the cash index closed at 6,456, while the March future was settled at 6,439. The Nifty Junior closed at 7,431, while the future settled at 7,418.

The Nifty Midcaps 50 closed at 2,241, while the futures closed at 2,170. The CNX IT closed at 3,501, while the future was held at 3,511. The lack of liquidity in April futures is crippling. The rupee should rise, given the latest Fed cut.

That will knock out the IT index. It's anyone's guess if there is sufficient liquidity to arbitrage differentials in the Midcap 50. Going long is fraught with risk if the market drops - you don't have counterbalancing April positions.

In the Nifty options market, the trend is also interesting. There has been open interest expansion in both calls and puts. But, in the calls segment, there has actually been a nominal open interest reduction in March contracts, though there has been strong expansion in April. In puts, there has been expansion across both March and April.

This is one clear indicator that sentiment is bearish. Another indicator is the put-call ratio (PCR). The overall PCR in terms of open interest is 0.85, while the PCR for March is 0.79 and the PCR for April-May is 1.31.

The overall open interest for April-May contracts amounts to just 16 per cent of the total open interest. A 0.79 ratio is massively overbought and bearish, while the April-May ratio is also low "� it is often above 2 at this stage of the proceedings.

In technical terms, given that the market broke a strong support at 4,600 on Monday March 17, we could see another sharp downturn. Opposed to that, there is likely to be short-covering across the cash market and in stock futures as well as options. The bearish factor though is more pronounced, given that the Nifty contract has high volume focus.

In that case, the market could drop below 4,400, if it breaches the 4,500 support, which held on Monday 17 "� there is strong support at 4,500 and again at 4,400. In fact, there is put liquidity down to 4,200 levels. On the upside, March call liquidity is available till about 5,700! At a guess, people holding long calls above 4,900 will lose 100 per cent of premium, since they will find it impossible to find counter-parties. The market is expected to swing anywhere between 4,300 and 4,900.

There are several interesting spread possibilities. Go with very close-to-money spreads if you want March contracts. That way, there are near-guarantees that you will hit them and the risk-reward ratios are quite decent. If you want a strangle combination, use April contracts, which will not be doomed by the expiry factor.

A bull-spread with long March 4,600c (Rs 80) and short 4,700c (Rs 39.85) costs about Rs 40 and pays a maximum of Rs 59.85. A bear-spread with long March 4,500p (Rs 67.45) and short 4,400p (Rs 40.45) costs Rs 27 and pays a maximum of Rs 73. There is a high probability of both spreads being hit.

A long strangle of long April 4,400p (Rs 159) and long 4,700c (Rs 150.25) costs Rs 309. Combine this with a short strangle of short April 4,200p (Rs 113) and short April 4,900c (Rs 86). The combined position costs about Rs 110 and pays a maximum of Rs 90, if the market does swing to either 4,200 or 4,900 inside April 24.

STOCK FUTURES/OPTIONS

The lack of liquidity outside the Top 20 contracts and the lack of liquidity in April futures are both worrying factors. It is difficult to suggest positions that may expire in four days without the comfort of carryover. However, as a general rule, long April, short March calendar spreads will work because of the carryover factor.

There are two or three interesting possibilities. One is a long Satyam position, another is a long Ambuja Cement position and the third is a long ICICI futures. In each case, there is enough April liquidity and evidence of carryover to offer comfort.