The uptrend has lasted over 12 weeks and it could soon reverse intensifying the downward momentum
The derivatives market was characterised by steady volumes and narrow range-trading last week. There was underlying nervousness and premiums rose as there were net losses pretty much across the board.
Index strategies
It is unusual for daily ranges to remain tightly constricted when there is an apparent trend and volumes are reasonable. But this was the pattern last week. Volatility is due to spike soon. It is extremely unlikely that range-trading will continue. Last week's pattern could be described as a short-term correction inside an intermediate uptrend. However, the uptrend has lasted over 12 weeks and it could soon reverse. In that case, the downwards momentum will intensify this week.
If the downtrend is confirmed as an intermediate reversal, the projected target would be in the range of 4,600-4,750. That is a minimum of 200 points down from current levels.
On the other hand, it is possible that the support between 4,900-4,950 will hold. In that case, there will be a final up move within the settlement and upside targets of 5,200+ would be met. The direction is likely to be determined by institutional attitude. If the DIIs and FIIs continue to maintain a net negative attitude, the downtrend is bound to intensify. If institutional attitude switches, the intermediate trend could continue north over the next 3-4 weeks. There is a mixture of negative and positive indicators but the sum of expectations seems bearish. One clear negative is the fact that most of the high-weighted, high-volume stock futures were settled at a discount to the respective underlyings. However, volumes are good and there could even be a recovery triggered by short covering.
Among the subsidiary indices, the CNXIT started underperforming last week, dropping over 7 per cent while the Nifty dropped less than 3 per cent. This downtrend coincided with Infosys' Q2 results and guidance, which were about as good as expected. The major negative factor was a strong rupee. The forex consensus appears to be further rupee strengthening. There is a strong possibility that the CNXIT will continue down.
The Bank Nifty outperformed the Nifty, losing 1.9 per cent. The outlook isn't great for bank stocks. On one hand, interest rates are unlikely to soften in the face of rising inflation. However, an ongoing industrial recovery would boost bottomlines and reduce NPAs. The Bank Nifty will probably continue to outperform the Nifty and it could be a driver every time there's a market-wide recovery. Hedge ratios rose as did implied volatility. Both are signs of nervousness. But open interest also rose and the carryover picture seems to be good with open interest (OI) increasing across both November puts and calls as well as November futures. These are bullish signals. The Nifty put-call ratio (PCR) was in a healthy zone across both the October settlement and beyond.
Expectations in the October settlement are focussed within the 4,700-5,300 range if we go by volumes in the option chains. OI in the Nifty put chain peak at 4,900p (62.6 lakhs) and at 4,700p (55 L) with a sharp decline at 4,600p (28L). OI in the call chain peaks at 5,000c (47L) and remains high till 5,300c (42.6L) dropping at 5,400c (16L). The October PCR is at 1.26 in terms of OI and it's at 1.25 overall.
Option traders can safely take spreads till either end of this range. If you wish to sell uncovered options, go till the limit (4,700p, 5,300c) or beyond. A standard close to money bullspread of long 5,000c (98) and short 5,100c (60) costs 38 and pays a maximum of 62. A standard CTM bearspread of long 4,900p (117) and short 4,800p (81) costs 36 and pays a maximum of 64. These are pretty fair risk-reward ratios. Note that the put premiums are more than the calls - this reflects bearish expectations.Further from money, two-way positions can be created. A strangle such as long 5,200c (33) and long 4,700p (56) can be laid off with a short 5,400c (8) and a short 4,500p (23) for a net cost of 58. This long-short strangle combination would breakeven at either 5,258 or 4,642 and return a maximum 142 in either direction. That is a decent risk-reward ratio but in practice, a move till the limit is unlikely within the settlement.
The other way to create two-way positions is to combine a long (short) Nifty futures position with a bearspread (bullspread) as a hedge. In this, the futures position would have to be tightly stop-lossed at say, 5,000 for a short future and 4,900 for a long future. The advantage is that this position works well if the market does move in the direction of the future and it is activated closer to money than strangles. The downside is that the losses could be quite a bit more, maximising at around 85-90 if the stop loss is struck and the hedge option spread doesn't activate.
| STOCK FUTURES/ OPTIONS Many of the highly active stocks in the derivatives segment appeared to be bearish. The majority of the list saw Friday's futures settled at discounts to the underlying value. There are several attractive shorts apparent. Maruti Suzuki for instance, is likely to be a good short and so is L&T. The metals segment also looks weak. However, there could also be a trend of short-covering in several of the more beaten down stocks. Airtel may just have moved into an oversold zone and DLF also offers a potentially interesting long position. Sugar shares like Renuka, Balrampur and Bajaj Hindustan are generating a lot of volumes and may be due for another up move as well. |
