Opportunities on Nifty Bank after rate hike

The immediate impact of the Reserve Bank of India (RBI) Monetary Policy Review has not been negative. The market was braced for a 25 basis hike. The policy statement projects somewhat heightened inflation, but is otherwise positive in its outlook. The central bank expects growth to stay on track. 

Inflation is still at acceptable levels. But it is climbing. Crude oil prices are volatile and likely to rise. The rupee is taking a beating. The fact that several banks had chosen to hike rates ahead of the review tells us that the cycle has switched.

This is the first rate hike since the Modi government came to power. It is likely to be followed up by further tightening. At the very least, yields are unlikely to come down during this fiscal. Higher rates are acceptable in circumstances where growth is causing or likely to cause overheating. Growth has not accelerated very much, but the statement says that the MPC (Monetary Policy Committee) believes the output gap has narrowed. 

There are opportunities for traders here. While the market actually had a small relief rally on the basis of a minimum rate hike, the trend is likely to stay negative, especially for financial stocks and working-capital-intensive businesses. The Nifty Bank may go into a downtrend from here onwards and the rupee may continue to show unusual volatility.

Derivatives on these underlying assets can be traded. Trading the rupee requires huge leverage and is therefore, highly dangerous, though it could be the most lucrative asset to target. Futures on bank stocks, or on the Nifty Bank are safer. Long options on the Nifty Bank are the safest of all. A long option position or a spread has losses limited to the initial premium paid. The gains can be unlimited.

Three types of positions can be taken with some degree of safety and some chances of a large profit. One is the hedged futures position with a “view”. Take a long or short futures position on the Nifty Bank, in the direction where you think it will trend. Hedge that with a long option in the opposite direction. If you're right, you'll lose the option premium and the futures will gain. If you're wrong the long option will come into the money and to some extent, balance off futures losses. If you have a perspective till the end of the settlement, going short with a June 28 Nifty Bank futures seems okay, with say, a long call at June 14, 27,000c (50). 

The second type of setup is the bullspread or bearspread. Again, this is a position with a “view”. Take a bullspread if you think a rally is in the offing and a bearspread if you think the Nifty Bank will fall. Assuming you're looking at a bearspread, a long June 28, 26,000p (230), short 25,500p (115) costs 115 and it could pay a maximum of 385.

The third type of relatively safe position is the strangle. Take a long put and a long call to ensure that you'll gain, regardless of market direction, if the Nifty Bank swings enough. A long June 28, 27,000c (137), long June 28, 25,500p (115) can be offset with a short June 14, 27,000c (50), short June 14, 25,500p (30). The net cost is 172, with break-evens at 25,328-27,172. 

The technical signals suggest that a downtrend is much more likely. The rally on the RBI news is unlikely to last long. The high volatility implies that traders can take Nifty Bank option positions 500-1,000 points from the money since this is early in the settlement.