Don't look at September yet, accept the expiry risks and stick to August.
The derivatives market continued to register high volumes despite very low interest in the spot market and disinterest from the FIIs. The settlement is likely to see fair carryover and a short-covering trend towards the last few sessions.
Index moves
The cash market is registering extremely low volumes and other bearish signals such as poor advance-decline ratios and net declines in all indices. However, the derivatives market is showing strong volume action though many positions have been extinguished in the last two sessions.
The pullback of FIIs has been a noticeable feature of the past three weeks. Although they have been net sellers through 2008, they have maintained major derivatives exposures throughout with combined positions usually about 40 per cent of all outstandings. That has now dropped to around 34 per cent. This could be due to a combination of P-Note cutbacks and/or a general loss of interest in Indian equity.
Additionally however, FII index option exposure has increased as a percentage of their total holdings. This usually presages change in their cash market attitude and it could mean short-covering is about to occur.
Indian operators also started to cut back on exposure ahead of settlement and full margins from Monday. In the past three sessions, a massive number of August Nifty futures have been extinguished though there has been reasonable carryover.
About 17 per cent of all futures OI are in September contracts. All September index futures are priced extremely close to August contracts and there is no question of arbitrage. Nor is there much differential between spot values and Friday’s futures prices.
The CNXIT, Midcap-50 and the Junior don’t have much OI. But there is unusual activity in the Bank Nifty, which has taken a hammering. There is also a fair carryover trend in the Bank Nifty. If one examines the price lines of major banks as well as volume patterns, it seems that short-covering has started in the sector. While this is contrarian advice, it may be worth being long Bank Nifty till Wednesday or Thursday since the index has a history of sharp recovery moves.
The VIX is emitting puzzling signals as it has been for a while. In early August, as the index was rising, the VIX was also hitting highs above 50. That was unusual since the VIX is usually reverse-correlated with price lines.
Now, as prices are falling, the VIX has settled into a groove of 32-36. This is on the higher side but not a particularly fearsome level. However, the VIX is unreliable in the last eight sessions of a settlement because it gives too much weightage to far month contracts at that period. It’s safe to assume intra-day volatility is likely to be quite high in settlement week, as it usually is, regardless of price trends.
Interestingly, in the options market, OI has expanded across mid and far month while it has dropped quite noticeably in near month. The August put-call ratio (in terms of OI) is exceedingly low at 0.8 and the overall PCR is also low at 1.02. Prima facie, this is a bearish signal.
Around 26 per cent of OI is in December 2008 and beyond. The high volume Dec 2008 4,500p (premium 420) and Dec 2008 5,000p (760) have breakevens at 4,080 and 4,240 respectively and there is significant liquidity in the 3,600p (103) with a breakeven of 3,497. The corresponding high volume Dec 2008 calls are 4,500c (248) and 5,000c (101) with breakevens at 4,750 and 5,101 respectively.
Since the breakevens range from a pessimistic 3,500 to an optimistic 5,100 by December, we could assume that the market expectation is inside the range of roughly +/- 1,000 points of current values until the end of calendar 2008.
In the immediate future, settlement week is likely to see values bounded within 4,150-4,450 with large daily ranges. This suggests traders should stay close to money. If you wish to go far-from-money, go with September options.
A bearspread with long Aug 4,300p (50.5) and short 4,200p (22.5) offers a maximum return of 72 on a cost of 28. A bullspread of long Aug 4,400c (33.65) and short 4,500c (12.7) costs 21 and pays a maximum of 79. There isn’t much difference in the risk-reward ratios for August. The bearspread is closer to the money but the bullspread has the better risk-return ratio.
A wider set of positions can be constructed using mid-months. A bearspread with a long Sep 4,200p (126) and a short 4,000p (70.55) costs 56 and pays a maximum of 144. A bullspread with a long Sep 4,400c (131.35) and a short 4,600c (57.8) costs 73 and pays a maximum of 127. At longer timeframes, the bearspread has a better risk-reward ratio.
My gut feel is that it’s not worth looking at September yet. Accept the expiry risks and stick to August. There, it’s a toss up between bearspreads and bullspreads. As of now, straddles and strangles also look uncertain. The index appears range-bound and straddles and strangles only make sense where a big move is likely.
| STOCK FUTURES/OPTIONS The 39 new entrants haven’t developed an exceptional trading profile yet. If the trend of last Friday holds, the next four sessions will see a fair amount of short covering. Banks are among the most tempting targets if you decide to gamble on that but we’ve already suggested a long Bank Nifty. Among stocks, Renuka (spot: Rs 127, futures: Rs 127.4) has a lot of volume and a price line that has already started to pullback Keep a stop at Rs 123 and go long with a target in the range of Rs 137 - Rs 140. |
