The bulls are winning but unless the major trend has changed, bears will come roaring back within the month.
The March settlement ended with the bulls clearly on top after a sharp rally. Volumes were up and volatility could rise through the April and May settlements. The market may be overbought and ripe for profit-taking.
Index strategies
There has been a breakout with the Nifty gaining over 15 per cent in the past 10 sessions. This move has come on high volumes and been accompanied by higher intra-day volatility. This is natural behaviour in the case of breakouts, especially upwards breakouts.
The pattern of high volume-high volatility is likely to continue through April for several reasons. Elections will definitely have an effect for one thing. Another factor is full-year results and 2009-10 advisories.
A third factor is that it is a rally inside a bigger bear-market which means sudden intermissions of panic selling. Direction is difficult to call because bear market rallies tend to be short but very steep while they last. The subsequent crash tends to be equally violent. Right now, the bulls are winning but unless the major trend has changed, the bears will come roaring back within the month.
It is possible that the market will see more net gains through the next week or two. But I think the advent of elections will trigger sell-offs, if it doesn’t happen earlier. Either way, daily volatility will be high. Traders will be inclined to book profits early and thus, contribute to choppy trading.
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In high volatility scenarios, premiums (that is, implied volatility) lag actual volatility. Derivatives traders should follow a few general rules. Don’t sell naked options is the first and foremost principle – the asymmetric nature of option returns makes this a dangerous game in situations where premiums understate the likely swings. Also, try to cater for moves in both directions. Third, set disciplined stop losses in futures positions.
The Nifty’s climb of 15 per cent was driven by heavyweights in the banking and finance sector. The BankNifty rose an astonishing 22 per cent in the past fortnight. The financial sector is strongly correlated to the overall market but it has a high beta and hence, moves a larger amount in the same direction. If you wish to take a futures position in the Nifty, take it in the BankNifty instead. The correct directional view will fetch higher returns.
CNXIT is more nuanced. The rupee has recovered from historic lows mainly because FIIs have been net buyers in March. However, the currency is still under pressure and it could collapse in April if FIIs panic. The CNXIT will tend to move against the currency.
Another factor is Infosys’ full-year result and advisory for 2009-10, which is gospel for IT analysts. A third factor is developments in Satyam, which could have a major impact on sector sentiments. Put it all together, and the CNXIT may not be that highly correlated to the overall market trend. Traders can slice Nifty-trading into several ranges for the sake of convenience. If it reacts, it has decent support at 2,850 and below that, all the way till 2,500. If it continues trending up, it could reach 3,575 before it runs into massive resistance. If it range-trades it will be stuck between 2,800-3,200 with a high degree of daily volatility.
In the trending situations, the highest returns would be available to a trader who has either the appropriate long options (or option spreads) far from money, or to somebody who gets in the right futures trade. In the range-trading cases, it would be close-to-money option spreads that deliver the best combinations of safety and return.
One clue as to the possible direction in the immediate future is the Nifty option put-call ratio. While the overall ratio in terms of open interest is healthy and bullish at 1.5, the April Nifty PCR is at 1.9. That is very high – probably unsustainable. It could mean a bout of profit-booking.
Bullspreads should focus on the call-chain of 3,200c (94), 3,300c (57), 3,400c (32) and 3,500c (16). A close to money spread of long 3,200c and short 3,300c costs 37 and pays a maximum of 63. A wider spread of long 3,300c and short 3,500c pays a maximum of 159 for a cost of 41.
Bearspreads should focus on the put-chain between 2,800p (41), 2,900p (59) 3,000p (85) and 3,100p (120). A close-to-money spread of long 3,100p and short 3,000p costs 35 and pays a maximum of 65.
A far-from-money spread of long 3,000p and short 2,800p pays a maximum of 156 for a cost of 44. A long strangle of long 2,900p and long 3,300c can be offset with a short strangle of short 2,700p (28) and short 3,500c. The net cost is 72 and the maximum return on a trending one-way move is 128. It is possible that the market would hit both ends of this strangle-set [see L-S strangles (2,700-3,500)].
All these positions offer positive risk-return ratios. The long-short strangle combination is attractive if the trader is prepared to hold until settlement week. Otherwise, there isn’t much difference between the far-from-money spreads so the trader would have to go with a directional view.
| STOCK FUTURES/ OPTIONS Very few stocks in the F&O segment will move against the overall market trend, whatever that is. One possibility is a long position in Tata Steel, which has just released a positive advisory. Keep a stop at Rs 215. Another possibility is to short RNRL – it seems overbought and could decline by 10-15 per cent. Keep a stop at Rs 52. |