CNXIT, Bank Nifty show opposite trends
The market saw practically no change in the major index levels in what is turning into an extended phase of very low volatility. Volumes in derivatives remained very low.
Index strategies
The week's high-low range was between 5,170-5,300 while daily movements were restricted to within 100 points. F&O volumes were extremely low---below Rs 50,000 crore per session. FIIs retained 33 per cent exposure in terms of all open interest (OI), which is slightly low.
But the main culprit for low volumes is probably the Indian retail and operator segments. The FIIs and DIIs have together been net buyers of over Rs 8,000 crore in 2010. Since the market hasn't moved at all, this has perforce been matched by retail-operator selling against delivery. The retail-operator communities don't hedge much and seems to be going for lower collective equity exposure. There may be broader implications in this but that is beyond our focus.
Implied volatility dropped last week. Option premiums far from money reduced with an early expiry effect. What with the market hardly moving, there seems little point for the average trader to take wider positions.
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This is the fourth week in a row with a low volume-low volatility pattern. It is very unusual and it cannot continue for much longer. If volumes don't return, at some stage, the market is going to ease down due to lack of demand.
However there are no apparently bearish indicators if we discount the low F&O volumes (cash market volumes are near-normal). The Nifty's put-call ratio is in the normal-bullish zone at around 1.3 (in terms of OI). Also, while volumes are low, OI has increased in most index instruments and the carryover patterns fall within normal limits. So there isn't overt bearishness or even worse, a fear of future liquidity drying up.
Another reason for lack of direction has been opposite trends in banking and IT sectors. The IT sector has risen 5 per cent in 2010, following up on an excellent 2009. Good results and advisories from IT majors added to momentum last week, when the CNXIT jumped 9 per cent, despite the rupee hovering between Rs 45-46.
However, banking has been very muted due to fears caused by rising inflation. Almost every market observer now expects a hike in CRR and perhaps, in repo and reverse repo rates. The Bank Nifty has moved down in response to these fears. Until this situation plays out, with the RBI taking some concrete action, the financial sector will look shaky.
Both subsidiary index futures have good liquidity. The CNXIT has over 1 lakh OI while the Bank Nifty has 11 lakh. That is indicative of trader focus on these two sectors. Given their weights in the Nifty, it's unlikely the overall market will develop a directional pattern until the CNXIT and Bank Nifty start aligning.
There are two weeks left for settlement so traders have some time to seek either a breakout, or to trade within the 5,150-5,300 band that's prevailing. Dropping premiums have made risk-return ratios close to money (CTM) look quite attractive and, of course, somebody who does bet on a breakout that actually happens, will also gain.
Trader expectations are clustered in a narrow range as one would expect. In the January put option chain, the OI is massed between 5,000p(11), 5,100p (23) and 5,200p (47). In the call chain, the OI is clustered mainly between 5,300c (45) and 5,400c (16).
A CTM bearspread of long 5,200p and short 5,100p therefore costs about 24 and pays a maximum of 76. A CTM bullspread of long 5,300c and short 5,400c costs 29 and pays a maximum of 71. Both spreads have excellent ratios and combining them yields a long-short strangle combination, which costs 53 and pays 47 if the market moves to either limit of 5,100, 5,400.
The breakevens on this long-short strangle combination are at 5,147, 5,353. This is a reasonable position since the lower breakeven is likely to be touched even without a genuine breakout. In practice, we would expect some payoff in that situation since CTM put premiums would rise. Reversing the position to take a short-long strangle (short 5,200p, short 5,300c, long 5,100p, long 5,400c) would yield an initial premium pay-in of 53. That's also a reasonable position if you don't expect a breakout before expiry.
If you do expect a breakout, you could try a long strangle with long 5,100p and long 5,400c, which costs 39 and breaks even at 5,061, 5,439. The cost could be reduced by taking a short 5,000p (11) and short 5,500c (5) to a net payout of 23 with breakevens at 5,077 and 5,423.
A long call butterfly with one long 5,200c (99), two short 5,300c (2x45) and one long 5,400c (16) costs net 25 and this is the maximum loss. The butterfly could yield a maximum return of 75 if the market expires at 5,300. It will outscore the short-long strangle combination if the market rises above 5,279.
| STOCK FUTURE/ OPTIONS The stock F&O market has very mixed signals because it's results season. Banking is down, IT is up. Among other sectors, cement is up and shipping-related stocks are up. Energy stocks seem to be down. PSUs are looking bullish but futures volumes in many of these counters are low. One possibility is to take a long Bank Nifty position betting on a technical recovery. If you do this, you may choose to hedge with a short SBI. Another possibility to go long on Tata Motors since the stock seems to be reverting to bullish after a spurt of profit-booking. |