High turnover and high volatility characterised trading last week. The FIIs increased their derivatives exposure as the market made a U-turn in mid-week.
Index strategies
Daily volatility increased with three big swing sessions. Expectations of continued volatility were reflected in a rising VIX and high F&O turnover. The FIIs switched attitude, turning net buyers after having sold over Rs 5,000 crore in the last two weeks of October. They also increased derivatives exposure to 36 per cent of all open interest (OI).
There's plenty of time for substantial moves in either direction. Although the market seemed to have established an apparent downtrend with a 13 per cent reaction, the 5 per cent rise in the past three sessions introduces the possibility that the downtrend has ended. Directional trends are unclear. There are some bullish signals. OI and derivatives volumes have been high along with decent cash market volume. There's substantial December OI in both option and futures segments. The put-call ratio is firmly bullish.
However, there are also bearish signals. Index futures are all trading at discounts to their respective underlyings. The higher VIX suggests nervousness. The technical situation suggests that while the correction has been sharp enough in dimensions, it has not lasted long enough to play out.
Trader expectations for November are focussed in the 4,500-5,000 zone. This does mean that a breakout from either end of this zone could cause panic. There is a reasonable chance such a breakout will occur because two up trending sessions in succession could take the Nifty past 5,000, while three down trending sessions would push it below 4,500.
The rupee has hardened and there's an inference to be drawn. For what it's worth, most forex traders believe that the dollar will remain weak through this quarter, staying below Rs 48. But FII attitude also has short-term influence on rupee direction. If they buy, the rupee appreciates. If they sell, the dollar appreciates.
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FII buying would be integral to any sustainable upmove, assuming other things such as DII attitude (which is bullish) and domestic operator attitude (by inference, bearish since the DIIs and FIIs were net buyers) remain the same. Hence, the CNXIT is likely to underperform if the market rises while it will display defensive strength in downturns. A long CNXIT is therefore, a good bet for the bearishly inclined.
The Bank Nifty was hit by the last Credit Policy when it became apparent the RBI was more interested in targeting inflation and preventing real-estate bubbles than enabling growth. Real estate shares were also hit. However, both sectors bounced last week. The heavyweights in these two sectors exert a lot of influence on the Nifty-Sensex and Junior. Any further rise in the Nifty has to be backed by recovery across these two sectors. A long Bank Nifty is therefore, a good bet for the bullish trader.
Option traders have a wide range of possibilities. In the broadest terms, they could expect further volatility, which makes option-selling and spreads that rely on low volatility dangerous. As mentioned above, expectations are concentrated between 4,500 and 5,000. The put option chain has maximum OI between 4,500-4,800 while the call chain has maximum OI between 4,700-5,000. Given prevailing premiums of the 4,500p (38.5) and the 5,000c (39), there will be stress if the market threatens to go beyond 4,462-5,039.
One technical issue is that the Nifty future was settled at 4,790 with the underlying closing at 4,796. This makes 4,800c (113) and 4,800p (126) on-the-money for all practical purposes and a long straddle at 4,800 would breakeven at 4,561 or 5,039. If we're constructing close to money (CTM) spreads, it is best to move slightly away from the money. A CTM bull spread of long 4,800c and short 4,900c (69) costs 44 and pays a maximum 56. A bear spread of long 4,800p and short 4,700p (84) costs 42 and pays a maximum 58.
A further from money bull spread of long 4,900c and short 5,000c (39) costs 30 and pays a maximum of 70 while a bear spread of long 4,700p and short 4,600p (57.5) costs 26.5 and pays a maximum 73.5. Given volatility, the superior risk-reward ratios of further from money spreads is worth punting on.
In the absence of clear direction, two-way positions must be investigated. A long strangle of long 4,600p and long 5,000c costs 87. If it's laid off with a short 4,400p (25) and short 5,200c (11), the net cost is reduced to 51. The breakevens would come at 4,549 and 5,051 with a maximum one-way return of 149. This long-short combination is unlikely to be fully realised but it has a very good risk-reward ratio.
A long (short) future with a far-from-money bear spread (bull spread) hedge could also work though this would depend on stop losses. For instance, a long future with stop at 4,750 and long 4,700p-short 4,600p hedge could lose a maximum of 66.5, with unlimited gains above 4,817 and a maximum gain of 7 on the downside.
| STOCK FUTURES/ OPTIONS Most stocks will move with the market trend and we don't have a clear idea what that could be. Sugar however, continues to be on a roll. Apart from the bullish sugar sector, there are also potential long positions in HDIL, Sesa Goa, L&T, Mphasis and Suzlon. Aban may also be rebounding on short-covering after taking a hammering early in the week. Potential short positions include Educomp, IFCI, Idea and Reliance Capital. It is also worth watching PSUs such as NTPC, Bhel and Gail since these could suddenly due to the PSU disinvestment programme that has just been announced. |