With the CNXIT and Bank Nifty having a weight in the Nifty, a fall in both these indices is likely to push the Nifty lower.
The cash market weakened considerably and by Friday, looked poised for a downside breakout. The derivatives market saw a volume jump in response.
Index strategies:
F&O volumes climbed in a falling market, but oddly enough, open interest (OI) also rose, especially in index instruments. Higher OI and higher volumes in a falling market can be read as a situation where long traders switched to short positions instead of exiting.
The FIIs did take the exit option. FII OI dropped to around 35 per cent, which is about 5 per cent lower than normal exposure. Since this was accompanied by a major selling spree, it could mean that they are out temporarily. Indian traders took up the slack.
One puzzling factor is that implied volatility has not risen, even though the market fell substantially. The Vix is locked at around 30, which is neutral.
A low Vix suggests that there is no undercurrent of fear, but the Vix has proved unreliable in its short history.
The fall was a little surprising because macro-economic signals were not particularly poor. Crude prices dipped below $100, always a good sign. The rupee did weaken sharply, but that is usually accompanied by rising IT shares. Indian T-Bill yields softened as the WPI numbers indicated that inflation was a little lower.
But, there was a triple whammy across the Banking, IT and refining sectors. The BankNifty slid, and the CNXIT crashed on Friday giving back earlier gains. Refiners including top-weighted Reliance Industries lost ground.
The September Nifty, Bank Nifty and CNXIT futures settled at premium to underlyings but that is not a strong signal. All three saw rising OI in the September index futures.
As things stand, the CNXIT and the BankNifty both look weaker than the Nifty itself and so do the Junior and the Midcaps-50. The latter two indices have hardly any futures’ OI, but the CNXIT and the Bank Nifty are both liquid. These sectors have Nifty weights and a fall in both these is likely to mean a falling Nifty.
Unfortunately, no calendar arbitrage positions are available. Only the October Nifty has OI and it is at almost exactly the same level as September Nifty. A simple view would be to take short futures positions.
The hedgers view would be something like a short position in an index coupled to a long position in heavyweight index stocks. In the Bank Nifty, the ideal choices would be Axis or ICICI. In the CNXIT, it would have to be Satyam or Infosys to balance the index.
The technical perspective on the Nifty is easy enough. It has tested a key support at 4200 and it will probably test that resistance again early into next week. If the support breaks, the index will fall quite sharply because that will confirm a new intermediate downtrend. If the market closes below 4180, it could fall by up to 400 points before finding a new bottom.
If the support holds, the Nifty will probably continue to range-trade. A pull up is only possible if there is new buying evident in certain quantity. Unless the institutions and the foreigners step in, that looks unlikely.
This is a short settlement, but it doesn’t go full margin until September 22. Next week therefore is unlikely to see large amounts of short covering even if the market breaks. In fact, after eight weeks of generally uptrending or sideways movements, the chances are high that a downside breakout would lead to frantic long-covering and margin calls that drive the market down further.
In Nifty options, the impact of the bearishness is clearly evident from the put-call ratios. While OI expanded overall, there has been a cashing out in the puts. As a result, the PCRs suggest that the market is overbought at current levels. The overall PCR (in terms of OI) is at 0.94 while the PCR for September is at 0.74. Both ratios are low and bearish – in fact, the September ratio is extremely low. This almost guarantees a sell off.
However the October and beyond PCR is at 1.4 which is normal. This suggests that the market doesn’t yet see this as an intermediate reversal. To an extent, it explains the puzzling Vix behaviour since the calculation gives weight to mid-month and beyond.
Since we’re getting closer to settlement, there is not much percentage in either wide option spreads. Nor is there much point in straddles and strangles since the upside is restricted.
Risk reward ratios on options spreads are almost exactly even and the Nifty future was settled at 4245 which means that the close to money calls and puts are nearly equidistant. A long 4300c (89.8) and a short 4400c (54.7) costs 35 and pays a maximum of 65. A long 4200p (96.05) and a short 4100p (61.2) also costs 35 and pays 65. Obviously I would prefer the bearspread but the bullspread could also work if the 4200 support holds.
| STOCK FUTURES/OPTIONS The most tempting stock futures positions consist of shorts given the way the market is heading. If there is a general breakout, very few scrips will move in the opposite direction. Several stocks have already made promising downside breakouts. One possibility is a short RNRL – it could drop till around the 80 level. Keep a stop at 91 (the Sept future was settled at 88.70). Another possibility is a short Relinfra and a third is a short DLF. Keep stops at 945 and 480 respectively and target a fall till 890 and 445 respectively |
