Volatility could increase through the week

Mini breakout maybe unsustainable

Despite low volumes the settlement went through with net gains. The market looks likely to correct from higher levels.

Index strategies
The settlement didn't see much volatility with prices between Nifty 5,190-5,300. Trading volumes were on the low side throughout. But carryover was respectable. FIIs maintained a positive attitude with net buys and held about 38 per cent of all derivative open interest.

The market is interestingly poised after a mini-breakout. It crossed resistance in the 5,250 zone and closed above that level. However, volumes were low and momentum only marginally positive. The upside target would be 5,300-5,350. Weak background indicators suggest a correction is imminent. Hence, chances of reactions from higher levels. A breakout should mean volume expansion and added volatility.

Monday is currency futures settlement. The dollar slid 0.25 in the past week to Rs 45.245, while the last RBI reference rate was Rs 45.34. The April $/Rs futures is trading at 45.3975, with room for a lot of arbitrage. Short-term FII attitude may be affected by currency moves. Good carryover was accompanied by rising OI in stock and index contracts. Superficially, the market is showing no danger signals despite poor momentum and low volumes. The index futures all closed at around 0.3 per cent premium to respective underlyings. That's a bullish signal.

The Bank Nifty outperformed last week, recovering from a sell off after the RBI surprised by hiking a policy rate by 25 basis points. Yields in interest rate futures hardened slightly and there is some apprehension the April RBI policy will have more anti-liquidity measures. The CNXIT has flattened. The big guns Infy, TCS and Wipro saw selling towards the weekend. That may be tied to the Q4 results. In any event, if the rupee strengthens further, it's likely to have an adverse impact on the sector. The put-call ratios are in the normal-to-bullish zone for Nifty options. OI has increased across all series and 43 per cent of all Nifty option OI is in May and beyond. Premiums remain low.

The trader must be prepared for swings between 5,200-5,400 with a perspective of the next five sessions. The settlement is long (April 29) and it is statistically likely that there will be a large swing. If there is an intermediate trend reversal, the market could slide till 5,000 level by end-April, at least. A reinforcement of the current uptrend could push it till 5,500.

An examination of the April option chains shows that some traders are braced for moves till 4,800 while on the upside, there are optimists who have taken positions in the 5,500c. The April put option chain shows a lot of OI starting at 4,800p (12) and continuing via 4,900p (18), 5,000p (29), 5,100p (45), 5,200p (69) and some OI at 5,300p (105) as well. With the underlying at 5,282, 5,300p is in-the-money. The April call chain has OI clustered from 5,200c (164) up via 5,300c (101) and 5,400c (55) till 5,500c (27). There is a distinct drop in OI beyond 5,600c (12).

The close to money (CTM) bearspread of long 5,200p and short 5,100p costs 24 and pays a maximum 75. The on-the-money bearspread of long 5,300p and short 5,200p costs 36 and pays 64 maximum. This definitely looks attractive since it would be highly profitable even on a small sell-off. The CTM bullspread of long 5,300c and short 5,400c costs 46 and pays a maximum 54 while the long 5,400c and short 5,500c costs 28 and pays a maximum 72.

The wider 5,400-5,500 spread looks more attractive in terms of risk-reward ratios. A long straddle at 5,300 would cost 206 and can be laid off with short 5,500c and short 5,100p to lower the cost to 134. That gives breakevens at 5,176, 5,434 and maximum one-way returns of 66. A long straddle of long 5,200p and long 5,400c costs 124 and can be laid off with short 5,600c and short 5,000p to reduce net cost to 83. The breakevens are at 5,117, 5,483 with a maximum return of 117 on a one-sided move.

Neither strangles nor straddles have attractive risk-reward ratios. A trader who wants two-way coverage could instead try combining a long Nifty future (with a stop loss at 5,225 or 5,250) with a bearspread. A long put butterfly would be another way to hedge downside and it could be combined to a long Nifty future. The butterfly would consist of a long 5,300p, two short 5,200p and a long 5,100p. This costs a maximum of about 12 and pays a maximum of 88 at 5,200. The butterfly would be in the money between 5,112 and 5,288 while the long future would have an unlimited upside and it could be stop-lossed for a loss of 30-60 points. 

STOCK FUTURES/ OPTIONS

The stock market is showing very mixed sector trends. Tata Motors has a bullish pattern and there's sufficient liquidity in the 740 call (29) and the 760 call (20) to construct a bullspread. This costs a maximum of 9 and pays a maximum of 11. At Friday's close of Rs 746, it costs about 3. In the stock futures market, a long Axis Bank, a long Aban or a long DLF may be attractive. 

In Hero Honda, the future is trading at Rs 1,951, at considerable discount to underlying price of Rs 2,007. This could signal a weak opening or a situation where spot price falls while future rises. An arbitrage play would be a long future coupled to selling the stock in cash, and reversing the trades intra-day.