The market could swing between 4,600 and 5,100 within the next week with several 150-point sessions
A high volume settlement ended in decent carryover amidst serious losses for bulls. Volatility was up and likely to stay that way.
Index strategies
Persistent selling in the past 10 sessions by the FIIs helped trigger a collapse. As usual, when there is a breakout from range-trading, volumes and volatility jumped, in both cash and derivatives. The bulls sustained heavy losses. But movement was not entirely one-sided – there were sharp intra-day pullbacks. Carryover patterns are good. The FIIs hold 39 per cent of open interest (OI) and volumes are on the high end of normal. It seems FII selloffs were tactical rather than outright panic exits. At least part of the carryover is due to wounded bulls rolling over long positions.
The technical picture appears quite negative. The fall is reinforced by breadth – declines far outnumber advances. It would be prudent to expect a slide till at least 4,650 levels. Derivatives traders must watch intra-day exposures carefully.
The picture in the subsidiary indices is interesting. Both the Bank Nifty and the CNXIT have been impacted by several events. The rupee has fallen in part due to FII selling, while the RBI has raised the CRR 75 basis points without touching policy rates. The CNXIT lost more ground than the Nifty and most IT majors appear weak. In the derivatives market, the February CNXIT futures settled at a small discount to underlying. OI dropped on Friday, which is unusual on day 2 of a settlement. Chances are, despite the favourable weak rupee, the CNXIT will lose more ground than the Nifty in the early stages of next week, at least.
The Bank Nifty on the other hand, saw excellent carryover and OI expanded on Friday. The sector had a roller coaster ride. At one stage, it was down over 5 per cent week-on-week. Then it made a dramatic recovery and finally outperformed the Nifty. The February futures are trading at some discount to underlying. Most bank majors appear capable of a further pullback and it is likely that the sector will outperform in the early stages of next week as well. The market may have been overly pessimistic about RBI's determination to cut liquidity and it is now correcting up.
In the Nifty itself, the range of expectations has widened. The recent historical volatility is reflected in both higher premiums as well as OI spread across a wider range of the option chains. Technically, the market could swing between 4,600 and 5,100 within the next week. We could see several 150-point sessions. Given that it is a new settlement, the trader should be prepared for moves anywhere between 4,500 and 5,300 in the month. February usually sees greater volatility due to Budget expectations as well.
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The option chains reflect this. One heartening feature is that there is a great deal of OI in the March Nifty options series and beyond, with around 49 per cent of OI in March and later. This suggests that there are a lot of long-term players with deep pockets in the market. Another positive is that the put-call ratios (PCR) are back in the normal zone from being excessively bearish a week ago. The overall PCR for Nifty options (in terms of OI) is about 1.15, with February PCR at about the same levels.
The February Nifty Put option chain shows high OI starting from 4,600p (44), 4,700p (67) and an OI peak at 4,800p (99) with fair OI also in the money at 4,900p (143) and 5,000p (200). The February Nifty Call option chain has good OI starting at 5,300c (15), 5,200c (26), 5,100c (45), with an OI peak at 5,000c (75) and some OI also visible at 4,900c (117) and 4,800c (171). The 4,800c is in-the-money while 4,900c is more or less at-the-money with the Nifty closing at 4,882 on Friday.
Traders could look at going far from money given time till settlement and the promise of high volatility. A CTM bullspread of long 4,900c and short 5,000c costs 42 and offers a maximum return of 58. A CTM bearspread of long 4,800p and short 4,700p costs 32 and pays a maximum of 68 but the bearspread is much further from money. A wider bullspread of long 5,000c and short 5,100c costs 30 and pays a maximum of 70. A wider bearspread of long 4,700p and short 4,600p costs 23 and pays a maximum of 77. A long-short strangle combination of long 5,000c, long 4,700p and short 5,200c, short 4,500p (28) costs net 88 and pays a maximum of 112 if the market moves to either limit (4,500, 5,200). The breakevens would be at 4,612, 5,088. This is reasonable.
A short future with a stop loss at 4,950 and a bullspread hedge of long 5,000c and short 5,100c may also work, assuming you want a directional position with a hedge. That has an initial cost of 30, with unlimited gains if the market drops below 4,852. The maximum loss is 98 between 4,950 and 5,000. This reduces to breakeven, if the market rises till 5,098.