Low-volatility range-trading on the cards

DERIVATIVES

Opt for the bearspread of long 5000p and short 4900p.

The market surged in settlement week although volumes were very thin. Intra-day volatility dropped and the VIX also stayed at low levels. Sentiment seems to be positive heading into the new settlement.

Index strategies
FIIs were more active participants last week after staying in the background during the first three weeks of April. Local operators pulled back their horns and carryover wasn't very high. Volumes were exceedingly low with daily F&O turnovers down below the Rs 35,000 crore mark. FII outstandings rose to nearly 47 per cent of all positions, which underlines their importance in this market.

Thus far, the fear-hope equation of the Nifty VIX seems to be running along predicted lines. Followers of the original Chicago VIX have noted that it hits lower values as the market rises and vice-versa.

Well, the Indian VIX has dropped to below 30 and stayed there as the Nifty has risen from 4700 to past 5100. We don't have enough data to judge if this is an overbought VIX level or not but it hasn't changed much since the Nifty was at 4950 five sessions ago.

In the index futures market, liquidity and prices reflected the higher level of trading confidence. The liquidity in non-Nifty contracts is now significantly better than one would expect two sessions into a settlement.

The Nifty closed at 5112 in spot and it was settled at 5126, 5120 and 5117 in May, June and July respectively. The premium on Nifty May futures suggests that the market remains optimistic. There's not enough of a differential between May-June to suggest a calendar trade.

Other indices only had OI in May. The Junior closed at 8964 in spot and it was settled at 8954.5. The BankNifty closed at 7616 and it was settled at 7628. The CNX IT closed at 4165 and settled at 4166 while the Midcaps-50 closed at 2664 and settled at 2660. The Bank Nifty had the best OI "� almost a lakh. The differential in the BankNifty will probably ease on Monday because the spot is likely to catch up.

The Nifty options position doesn't offer much of a clue as to direction. There's been healthy OI buildup in puts and calls and across all months. The PCR (OI) is bullish overall at 1.39 while the May PCR is 1.24 which is also healthy. The PCR for June-July combined is 1.82, which is again normal, tending to oversold.

Technically, the Nifty has strong support at 5000, a likely upside target of 5200 and strong resistance above 5100. Intra-day volatility has dropped (as has the VIX) which means our current expectations are that daily high-low ranges will be 100-150 points, down from earlier swings of over 250 points.

All this suggests narrow range trading next week. A glance at the option chain makes that look even more likely. There's massive OI at 4900p and 5000p and similarly at 5200c and 5300c. The trader should therefore be focused on the range between 4900-5300.

A bullspread such as long 5200c (114.2) versus short 5300c (71.05) costs 44 and pays a maximum of 56. A bearspread of long 5000p (110.85) and short 4900p (81.2) costs 30 and pays a maximum of 70. Both risk:reward ratios are quite good for positions which are pretty much equidistant from the money and very likely to be hit. But the bearspread has a really excellent payoff. That would be the most preferred and obvious position to hold.

A combination of both positions is equivalent to a long strangle and short strangle. It costs 74 and pays a maximum of only 26 on either breakout. If you're looking for this sort of long/short strangle combinations early in a settlement, it makes sense to move further from the money. There is ample liquidity if you wish to try for this sort of position.

A long 5300c and long 4900p cost a total of 152. The net cost can be reduced with a short 4700p (44.5) and a short 5500c (25.85) to about 82. Then the maximum return on a breakout would be 118. If both sides of the position are struck, it's tempting since the return would be in the range of 236. A 400-point swing by May 29 is quite likely to occur if historical volatility is maintained.

STOCK FUTURES/OPTIONS

There are a plethora of potential stock futures positions. One possibility is to pick a high-velocity heavyweight bank share and go long since the entire sector looks as though it could run up.

The choices are Axis, ICICI, HDFC Bank and PNB. Of these, the most volatile is Axis but the ICICI futures (922) was generating a premium on spot (916). So either Axis or ICICI would be reasonable.

Another obvious long position is RCom (577). It doesn't look too risky but keep a stop at 570. A third, less obvious long position is TCS which has been sold down from 1305 to 890. It saw short-covering on Thursday and Friday and there's apparently strong support at current levels and a possible upside till 920. Long TCS does carry an extra risk since it's not clear if traders will revert to shorting post-settlement. If you do go long TCS, keep a stop at 880.

On the short side, Sasken Communications is a possible play. The stock has seen wild gyrations due to its buyback possibilities but that has been discounted and followed by downratings. It's likely to be sold down to 160 levels and maybe even 150, from the current 177.