Bullspreads close-to-money have somewhat lower risk-reward ratios than bearspreads.
The Satyam shockwave overwhelmed normal market trends and led to a sequence of panic selling across the board. There were some signs of recovery on Friday but the sentiment remains pessimistic.
Index strategies
While FIIs increased their derivatives commitments on January 9, they were clearly on the short side. Much of the volume expansion in the cash market came from FII sales against delivery.
There will have to be mathematical recalculations of index levels as Satyam Computer (SCS) is replaced in three key indices. However, SCS triggered shock selling amidst paranoid rumours in many index heavyweights. Reliance Industries and DLF were two counters which suffered from rumours. Both look bearish as do ICICI Bank and Bharti Airtel.
There has been some counter-balancing defensive investments in Hind Unilever and some speculative long positions in auto stocks like Maruti and Hero Honda as well as TCS and Infosys. This may not be enough for breadth is heavily in favour of declines. The other factor is Q3 results. As they are declared, trading towards the second half of the January settlement will become increasingly stock-specific.
Reflecting the pessimism, most index futures are trading at discounts to their closing underlying values. However, the most heavily traded indices are now standing at key supports. The BankNifty could see a tussle between bulls favouring PSU banks and bears hammering private banks. IT saw speculative buying ahead of Infy results. However, if Infosys disappoints the market, or if the rupee strengthens, the CNXIT could collapse.
The rupee could strengthen if the signals are right. The currency future contract (48.55) is at a significant premium to the RBI reference rate of 48.92. FII attitude would be a key short-term influence in terms of immediate direction of dollar-flow.
However, there have also been upheavals in USD-EUR and USD-GBP which could affect the USD-INR equation. Notably, FIIs have bought over Rs 2,000 crore worth of Indian debt in January 2009 when GoI security yields have been dropping. If inflows into rupee-debt continue, the rupee may gain anyhow.
The Nifty has been hammered down to hit support at 2,850. If the support holds, it’s likely to swing up again by about 300 points. But if the 2,850 support is broken, the market could also slide 300 points. We are likely to witness high-volume, high-volatility trading with 200-point intra-day swings through next week. The Vix is rising and may see a sharp spike if the market responds to the volatility by marking up premiums.
The Nifty PCR in terms of OI is at around 1.1 and the overall PCR is also around 0.96, which indicates some bullish sentiment exists. The volumes are heavily concentrated in the top 20 counters though overall volume has also increased.
Short-covering is unlikely to play much of a role until the weekend at least. Traders may cut off positions on the next weekend as they did last Friday. But there’s no settlement pressure.
Volumes and OI expanded on both sides of the option market. About 34 per cent of option volume is in February and beyond, which is lower than normal. Less than 2 per cent of Nifty futures volume is in February, which is again, very low.
The Nifty put-call ratio in terms of OI is around 1.1, which is virtually unchanged from last week and neutral in directional impact. The overall PCR was around 0.96 which is also neutral or even bullish. The January PCRs (OI) are bullish at around 1.25 while February and beyond is somewhat bearish at 0.87. The option trader is also constrained by the lack of liquidity in the Jan call chain beyond 3,350c. The trader should look at a target range of about 2,500-3,200 since the market could swing 300 points in either direction from the current levels.
Bullspreads close-to-money have somewhat lower risk-reward ratios than bearspreads though this maybe because the spot Nifty is somewhat closer to the nearest out-of-money call (2,900c) at 2,870. However, wider far-from-money calls have better ratios.
A bullspread with long 2,900c (113) and short 3,000c (70) costs 43 and pays a maximum of 57. A bearspread with long 2,800p (108) and short 2,700p (78) costs 30 and pays a maximum of 70. Obviously the bearspread is more tempting though both spreads have a fair chance of being hit by settlement.
Further from money, a long 3,000c and short 3,200c (21) costs 49 and pays a maximum of 151. An equivalent bearspread with long 2,700p and short 2,500p (38) costs 40 and pays a maximum of 160.
We can create long-short strangle combinations by taking pairs of these bullspread/bearspead combinations. A long 2,700p and long 3,000c (total cost 148) can be laid off by a short 3,200c and a short 2,500p (Total premium inflow 59) to create such a position with a net cost of about 90. The breakevens on this are at 3,090 and 2,610 and the maximum return is about 110 on a one-way move to the limit. A fairly tempting position if you can hold till settlement.
| STOCK FUTURES/ OPTIONS As mentioned above, there are many stocks that have bearish profiles and a few that have apparently bullish profiles. The auto sector in particular seems to be attracting speculative bulls. However, one set of likely winners are the stocks that will replace Satyam in the Sensex, Nifty and CNXIT. Of these, Sun Pharma has already been designated and started seeing investment from institutional players who are rebalancing index exposures. Sun has a bullish profile. Keep a stop at Rs 1,090 and go long with a target of Rs 1,150. |
