Most of the technical factors suggest that the market has not yet bottomed.
The sudden trend reversal in the last two sessions has been reflected in sharp premium changes. A lot of winning puts have been cashed out, leading to bearish put-call ratios.
Index strategies
Although trading volumes have remained high in the derivatives segment, there is an impression of a cash crunch. In the cash segment, profit-booking has turned into a selling wave while traders have been willing to book profits (or losses) early in derivatives.
A large number of August puts have been cashed in the past three sessions. At the same time, August Nifty futures positions have been extinguished. Even though Open Interest (OI) has expanded in September and beyond, the overall OI has fallen. Part of this could be due to margin calls. A little surprisingly, despite FII selling, the rupee strengthened. Normally, the CNXIT and the rupee have an inverse relationship but that has been violated in the past month when IT stocks have outperformed despite a strengthening rupee. This trend of strong rupee, strong CNXIT, continued last week with the index losing much less than the Nifty.
Banks underperformed the overall market with the Bank Nifty losing more than other sector indices. This was less surprising because the RBI has held policy rates stable rather than opting to cut in its last two reviews. However, any revival of the overall market is likely to be led by an outperforming Bank Nifty.
Right now, most of the technical factors suggest that the market has not yet bottomed. The standard momentum indicators are poor and not yet definitively oversold. The option put-call ratio is bearish. In terms of OI, the Nifty PCR is below 1 across all series. Technically, a Fibonacci analysis would suggest the down move may end at around 4,420. That’s the first possible retracement level. More likely, given generally bearish signals, the downtrend will continue.
The next clear support level is around 4,250. Given a pattern of recent high-volume trading between 4,200-4,700, the 4,250 level is likely to hold, at least until the end of the week. On the upside, there is continuous congestion and hence, resistance above 4,500 and all the way till 4,730.
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The trader should therefore be prepared for moves between 4,200-4,700. That’s a wide range at first glance but the market has swung 150-odd points per session for a while so it could be achieved in three or four trending sessions. Hence, option premiums are quite high at the moment reflecting both historic volatility and implied (anticipated) volatility.
There are two things the index trader could attempt in relative safety. One is to set up non-directional positions that could gain if the market makes a big move in either direction. The other is to set up spreads far from money with a directional bias. A third possibility is to sell options for the premium but this is not a safe strategy. While premiums are high, so is the historical volatility.
First, let’s see the directional situation. Close to money spreads have reasonable risk-return ratios. A long 4,500c (140) and short 4,600c (99) costs 41 and pays a maximum of 59. A long 4,400p (113) and short 4,300p (78) costs 35 and pays a maximum of 65. Further from money, a long 4,600c (99) and short 4,700c (66) costs 33 and offers a maximum payoff of 67. Similarly a long 4,300p and short 4,200p (52) costs 26 and pays a maximum of 74. It seems that the bear spreads are a little better.
Strangles are classic two-way spreads. A long 4,600c and long 4,300p costs 177 and it can be laid off with a short 4,800c (44) and short 4,100p (33) to reduce the net cost to 100. This long-short strangle combo offers a maximum payoff of 100 with breakevens at 4,700 and 4,200. It is a 1:1 pay off, which will only work if the market moves roughly 400 points. That is too much for comfort.
Of the other two-way positional possibilities, the most practical are combinations of futures plus option spreads. These offer breakevens closer to the money but the return is biased in the direction of the future. One way to increase the return is to sell two short options for every long option but that is risky because the second short option is naked.
Consider a long future with a stop at 4,425 and a bear spread with long 4,400p and short 4,300p. This has a maximum loss of 55 on the future and 35 for the spread, totalling 90 between 4,400-4,425. The breakevens are at 4,310 and 4,515 with unlimited upside and a maximum gain of 10 on the downside. If you sell a second 4,300p, the initial return is a net inflow of 43 but if the market does move below 4,300, you face unlimited loss.
The “mirror” position is a short future with a stop at 4,530 and a long 4,600c plus short 4,700c. This has a maximum loss between 4,530-4,600 of 83 and the breakevens are at 4,447 and 4,683. The downside gain is unlimited while the upside return is a maximum 17.
| STOCK FUTURES/OPTIONS Quite a few stocks are offering tempting short futures positions and there are a few interesting long futures positions. My instinct would be to stick to the top 20 stock futures contracts in terms of volumes and to keep tight stop losses. Two interesting possibilities are short Reliance Capital and long Sesa Goa. Reliance Capital could drop all the way till Rs 790-Rs 800 if the market goes into a tailspin. Keep a stop at Rs 865. Sesa Goa seems to have made a recent upwards breakout followed by a consolidation. Keep a stop at Rs 235. |