It is possible that the market will swing down till 3,850 and bounce within the next two or three sessions.
Spot market upheavals were mirrored by fluctuating premiums. Open interest (OI) grew across August and September even as FIIs booked profits and cut down derivatives exposures.
Index strategies
Premium volatility is unsurprising. But intra-day volatility has not increased despite the downside breakout from a trading range. FII spot selling was accompanied by profit-booking in F&O. F&O volumes stayed at Rs 60,000 crore but FII exposures (in terms of open interest) dropped from 40 per cent a fortnight ago to 33 per cent last Friday.
The pattern suggests many Texas hedges (short F&O positions mirroring spot sales). Winning shorts were cashed along with losing calls. OI dropped in July. FII unwillingness to open new F&O positions leads to an inference that some FIIs are abandoning India for the time being.
OI actually grew overall. On Friday, over 17 lakh new index option positions were opened in August-September, over-compensating for 4.5 lakh closed July positions. Expect more call-losses to be booked on Monday – the fall late on Friday stranded many long traders.
Rising Nifty options OI is matched by rising Nifty futures OI. Over 10 lakh new Nifty futures positions were opened last week. About 5 per cent of index futures OI is in the mid and far series. All series are at discount to underlying. The hedge ratio has risen.
The long-term OI shows most participants see this as a temporary downturn inside a bull market. That’s reassuring - the correction of the past four weeks has led to a 15 per cent pullback. Technically, the downside breakout makes retracement till 3,850 very likely. Falls below cannot be ruled out either.
More From This Section
All near-term signals appear bearish. The put-call ratio has dropped to around 0.8 (in terms of OI) on all series. That’s bearish to the point where one could hope for a corrective rally soon. It is possible that the market will swing down till 3,850 and bounce within the next two or three sessions.
As and when such a rally comes, it is likely to be led by short-covering in the Bank Nifty and bank shares. That sector has disproportionate losses with the Bank Nifty down nearly 14 per cent. This is in line with the Bank Nifty’s high-beta vis-a-vis the Nifty.
The CNXIT has outperformed due to the rupee’s drop. The rupee weakness is due to FII sales as well as increased fiscal deficit estimates in the Budget. The currency future is at significant discount to the RBI reference rate and this suggests further pressure.
In the very short-term, the bearish Nifty trend could be exploited by shorting the Bank Nifty though any such position must be carefully checked with a stop-loss. The CNX IT direction is difficult to judge. The rupee will drop further if FIIs continue to exit. That creates some buoyancy for the CNXIT but it may not be enough. There could also be arbitrage of IT stocks, which are trading at a discount to respective ADRs/GDRs. But the CNXIT lacks liquidity and the margins don’t justify stock-specific arbitrages.
In the index options market, many possibilities exist. A straddle at the money, with long 4,000c (119) and long 4,000p (134) costs 253. This is too expensive. Bull/bear spreads at the money are offering maximum returns of 60 on costs of about 40. The trader should move slightly away.
A bullspread with long 4,100c (79) and short 4,200c (48) costs 31 and pays a maximum of 69. A bearspread with long 3,900p (92) and short 3,800p (60.5) costs 31.5 and pays a maximum of 68.5. So the risk-reward ratios are good and much the same. The bearspread is more tempting for a directional trader.
The easiest hedged play is a long or short index future in the preferred direction combined to a spread in the opposite direction. A short Nifty stopped at 4,050 with a 4,100-4,200 bullspread would lose a maximum of 81 between 4,000-4,100. It would breakeven below 3,969, and above 4,181, with unlimited downside gains and a maximum gain of 19 on the upside. A long Nifty, stopped at 3,950, with a 3,800-3,900 bearspread would cost 82. Breakevens are at 4,032, 3,818. The upside is unlimited and the maximum downside gain is 18.
Strangles like long 4,200c and long 3,800p is also worth consideration. This can be laid off with a short 3,500p (12) and short 4,500c (9). The net cost is 89 and the possible maximum one-way return is 211 with breakevens at 3,711, 4,289. This is expensive but has a good risk-reward ratio.
Another possibility is to rely on the high sensitivity of premiums to changes in the underlying and create two-way positions. For example, combine a bearspread with a long 4,500c. The net cost is about 40 and the maximum downside return is 60. On the upside, the position is profitable if the 4,500c premium rises above 40. This is likely to happen if the market is within 200 points of the strike – that is, around 4,300.
| STOCK FUTURES/OPTIONS Banks are an obvious focus area for shorts along with the usual suspects like Suzlon, Reliance and Tata Steel. Axis and ICICI are high-beta with respect to the Bank Nifty. The danger is being wrong-footed when the short-covering starts. The ambitious trader will try to short first and then “double-plus” to benefit from the short-covering. |
Right now, Hind Unilever is a potential long position since the stock appears to be counter-cyclical. Reliance may also be worth a long position already with a stop at Rs 1,725. Another potential long position is Tata Motors – this looks oversold at current levels. Keep a stop at Rs 260 and go long.