Daily volatility may rise

Expect at least one big session in the coming week and another one in the settlement week with high-low ranges of 150-200 Nifty points.

The derivatives market saw one massive swing session on Thursday when the market turned around from support at 4,370. Apart from that, volumes were average and the expectations towards weekend were back to being bearish.

Index strategies
F&O turnover spiked above Rs 50,000 crore on Thursday as there was massive profit-booking by short traders around the Nifty 4,400-mark and below. On Friday however, volumes were back to a more normal Rs 40,000-odd crore. However, open interest (OI) continued to expand.

The FIIs continue to combine massive sales in the cash markets to a substantial presence in F&O. Right now, they hold about 39 per cent of derivative outstandings, which is a little lower than their market-share in the previous several months. During periods when they have been heavy sellers, FIIs derivative positions have often been pyramids with sales in cash backed by short futures positions.

It is when the FIIs start taking substantial options exposure that we get a warning that the selling pattern is about to reverse. At this moment, the options exposure is around 33 per cent "� if it rises above 35 per cent, I think traders must be braced for a bout of buying.

That could happen in the settlement week and much of the option exposure in that case would be in July instruments. The carryover into July at this stage is reasonable at around 26 per cent of Nifty options positions.

The expectations are clearly negative. The VIX has risen to above 30, which seems to be danger-levels. Most index futures are trading at substantial discounts to the spot values. The Nifty, for instance, is held at 4,484 and 4,475 in the June and July series, respectively, while it closed at 4,517 in spot.

The CNX IT, which lost over 5 per cent last week, was held at 4,323 in spot and at 4,271 in June. The Junior was marginally lower than the spot value, while the Midcaps 50 had negligible liquidity and was settled marginally above spot.

The Bank Nifty will be the focus of much interest given the repo hike. It has suffered more than the general market in the past 6 months, losing 40 per cent from its opening values in January, while the Nifty has lost about 28 per cent. It lost over 2 per cent last week, but it responded with a relief rally and consolidation after the rate hike.

The market may have expecting worse. However, on Friday the spot index closed at 5,993, while the June futures was settled at 5,953.

The consistent and large discounts to spot suggest that the downside expectation is substantial. In the Bank Nifty especially, the impact of likely rate hikes by various majors in early July have not yet been factored in.

But, there are also signs that the market is oversold when one looks at the options put-call ratio (PCR). The overall PCR for all options is at 1, while the Nifty PCR in terms of OI is in the range 1.7 for June options. These are at the higher end of the normal range. We could see a push till the 4,700-4,800 zone in terms of the upside.

A glance at the outstanding positions on the options chain clearly defines markets expectations. On the downside, put OI has a massive bulge at 4,200 where around 18 per cent of all outstanding put-strikes are located.

The call chain has about 14 per cent of OI at 4,800 and another 18 per cent at 5,000. The points 4,200-5,000 would be the outside limit of expectations. Chart analysis suggests 4,400-4,800 is more likely.

Expect at least one big session in the coming week and another one in the settlement week with high-low ranges of 150-200 Nifty points. The VIX suggests this and so does the trading pattern in various index heavyweight stocks.

In the Nifty options market, the situation favours strikes slightly away from spot if you are looking for a cheap play. There is enough volatility to suggest positions 200 points away from spot could be hit.

A long 4,600c costs 59.85, while 4,700c costs 30.8. The net cost on a bullspread would be 29 and the maximum potential payoff is 71. That is a great risk-reward ratio.

In puts, the 4,500p (118.65), 4,400p (82.1) and 4,300p (58.35) are the key instruments. A long 4,500p, short 4,400p combination costs a maximum of 37 and offers a return of 63, while the long 4,400p and short 4,300p bearspread costs 24 and pays a maximum of 76.

Both are decent ratios and likely to be struck. Obviously the overall bearish trends make the bearspreads more tempting and the close to money 4,400-4,500 looks like very high probability coupled to excellent risk:returns.

Strangles would have to be combinations like long 4,400p and long 4,700c versus short 4,200p (42.35) and short 4,900c (6.85). This particular set of long-short strangles costs about 64 and pays a maximum of 136. While the risk-return ratios are decent enough, the expiry factor needs to be considered.

STOCK FUTURES/OPTIONS

The sector trends have been broadly negative, but there are a few stock-specific moves generating positive returns. Two contrarian possibilities are long positions in DLF and REL.

Both stocks have taken a massive hammering in the past two weeks and the short futures' holders may now be looking to cash out. Another interesting long position is Mahindra LifeSpace. Set a stop at Rs 580 and go long with a target of Rs 620.

Dr Reddy's Labs and Aurobindo Pharma are two pharma stocks that have seen strong buying in the past days. Apart from these, the trader could short any major bank such as SBI, ICICI, Axis or PNB on general principles.