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<b>Derivatives Strategies:</b> Nifty more likely to head south

If the Fed does hike rates as expected, and produces a hawkish statement, the market would tank

Derivatives, Nifty, VIX
Devangshu Datta
Last Updated : Dec 13 2016 | 2:32 AM IST
The market is holding support above 8,150, despite the disappointment of the Reserve Bank of India (RBI) maintaining status quo in the policy review. Central bank inaction has caused a reaction down from the recent highs of 8,275. 

It's all eyes on the US Federal Reserve this week. If the Fed does hike rates as expected, and produces a hawkish statement, the market would tank. The other apparent negative in newsflow is the realisation that GST is not likely to happen in April 2017. 

On the upside, the 8,275 high would be a key level to beat. On the downside, a breakdown that pushed the Nifty below 7,915 (the three-month low) would emphasise probability of a long-term bear market. The dip on Monday has pulled the index below the 200-Day Moving Average (200-DMA). 

Whatever the Fed does will impact the rupee and all emerging market assets. The fear is that the dollar could rise and FIIs may pull out of all emerging markets. The FIIs have already sold over Rs 40,000 crore in rupee debt and over Rs 22,500 crore in equity since October.  If selling continues, the dollar could collapse to new historic lows. 

There could be a relief rally if the Fed does not hike rates. The Bank of England follows through with an advisory on Thursday where some sort of QE is expected, while the European Central Bank has decided it would start to taper its bond-buying programme in April. 

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Exporters are also afraid of likely protectionist actions in the US, including tighter visa quotas by the Trump administration, which would reduce access to the US market. This could impact Indian information technology (IT) companies in particular, which is why the traditional hedge of IT stocks against a higher dollar is not working so far. 
 
The VIX remains high and it is rising again. Corporate results have been poor and the prognosis for the second half is bad, going to worse. The November PMI indicates some collapse in sentiment as demonetisation impacts decisions. 

If the index does slides below 7,900, it could actually drop till 7,500-7,600. It does look more likely to head south, with occasional rallies. The Nifty Bank broke south on Monday. A long Nifty 18,000p (167), short Nifty Bank 17,500p (70) costs 97. This bear spread would be on the money, given one big down-trending session. Traders could also take the inverse position of the bull spread by selling the December 15, 18,000p (47) and buy the December 15, 17,500c (7). This cuts the cost of the December 29 bear spread to 57. If the bull spread is struck, the bear spread will rise correspondingly.

Put-call ratios (PCR) suggest that there is still some optimism since the PCR is above 1 for December, and for the next three months. The December Nifty call chain has high open interest (OI) till 9,000c with, the highest OI at 8,300c, and more peaks at 8,500c and 9,000c. The December put chain has a big peak of OI at 8,000p, with another bulge at 7,500p and good OI till 7,000p.  

The Nifty is at 8171. A bull spread with long December 8,300c (48), short 8,400c (22) costs 26 and pays a maximum of 74. This is 130 points from money. A bear spread with long December 8,100p (74), short 8,000p (49) costs 25 and pays a maximum 75. This is only 70 points from money.  

A wide strangle combining long 8,000p, long 8,300c costs 97 and it can be offset with short 7,900p (33), 8,400c (22) cutting the cost to 44. Breakevens are at 7,956, 8,344 but this is not zero-delta since the bear spread is further from money. 

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Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper

First Published: Dec 13 2016 | 2:25 AM IST

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