February settlement will be an extremely tense one with sudden trend reversals and large intra-day swings.
Sliding prices has triggered additional volatility with option premiums hardening. February is a relatively short settlement and likely to be tense due to a combination of weak global cues and Budget expectations.
Index strategies
There has been heavy FII selling across most equity markets as fears have surfaced about sovereign defaults in the Eurozone. India also has tightening rupee liquidity. The new euro-rupee currency contract is generating huge volumes. The USD has hardened, against rupee and Euro.
Indian equity prices have been falling since early January, when the last 52-week high (5,310) was registered. As such, the intermediate downtrend has lasted four weeks. It could last several more. February is always tense due to Budget considerations and this settlement ends February 25, a day before the Budget. Given the global bearishness, this will be an extremely tense settlement with sudden trend reversals and large intra-day swings. Derivative volumes have jumped along with volatility. There's been steady expansion of open interest (OI).
FIIs retain considerable F&O exposure at around 35 per cent of open interest. This suggests tactical withdrawal rather than abandonment of the Indian market. Their net sales of Rs 9,500 crore equivalent in 2010 has flushed out the more highly-leveraged players. Hedge ratios have risen. The increasing focus on index instruments is normal when the market is nervous. As of now, the Bank Nifty appears to be underperforming the Nifty while the CNXIT is doing slightly better. However, banks could rebound more than IT stocks if the Budget or associated monetary policy is assumed to be favourable for the sector.
We would expect a negative bias to direction, at least in the short-term. The Nifty put-call ratio is negative. Chart patterns suggest that support in the 4,600-4,650 zone will be tested, perhaps repeatedly. If that support is broken, the market could slide till the 4,450-4,525 levels. High-low ranges of 150 Nifty points per session may occur frequently. The movement will not be one way. Net losses will be tempered by sudden rebounds driven by short-covering or buybacks from sellers against delivery. The cash market is not registering very high volumes so any little increase in demand could drive the market up sharply.
On the upside, we would see strong resistance between 4,800-4,850, and again above 4,950. If the market can climb above 5,000 and stay above it, for a couple of sessions, the implications would be very positive. Traders need to be prepared for moves between 4,500-5,000 in February. They also have to be prepared for a massive swing early in the next settlement due to the Budget.
In the circumstances, don't sell options. While premiums may seem high, they probably understate the volatility of the next four weeks. Concentrate on very high liquidity counters. Either keep excess margin for adverse moves, or try and find hedges whenever you have exposure. Typically, that means finding paired assets such as a long Bank Nifty versus a short bank stock future.
Spreads close to money have reasonable risk-reward ratios. But the ratios get better if the trader moves further away from money. Given volatility, this seems like a fairly good situation for Nassim Taleb-style positions of cheap strangles far from money.
The close to money bullspread of long 4,800c (88) and short 4,900c (51) costs 37 and pays a maximum of 63. The corresponding bearspread of long 4,700p (94) and short 4,600p (60) costs 34 and pays a maximum of 66. Due to the Nifty future being settled at 4,757 (February 6), the two positions are near-equidistant from money. The Nifty put-call ratio for February (in terms of OI) is at 0.95 which is clearly bearish.
If you move further away, a long 4,900c (51) and short 5,000c (28) costs 23 and pays a maximum of 77 while a long 4,600p (60) and short 4,500p (37) costs 23 and pays a maximum of 77. These two spreads can be combined for a long-short strangle combination that costs an initial 46, with breakevens at 4,554 and 4,946. The maximum one-way return could be 54 from this position and there's a reasonable chance of profit from moves in both directions.
Alternatively, take the long 4,900c, long 4,600p and a short 4,400p (22) and short 5,100c (15). This costs 74, with breakevens at 4,526 and 4,974. The maximum one-way return is 126. If you want an uncovered "Taleb-style" position, you could take a long 4,400p and a long 5,100c. This costs 37 and it could yield massive returns if it comes close to being struck.
| STOCK FUTURES/OPTIONS Stick to the top 20-25 counters in the stock futures segment if you want safety. One problem with stock futures is that hedges are cumbersome and even the more liquid stocks don't have too much in the way of option liquidity. On the whole, shorts are far more likely to be profitable than long positions but there will be rebounds every so often. Keep disciplined stop losses and excess margin to handle potentially large adverse swings. Quite a few stocks have penetrated their own 200 DMA on the downside and done so on enhanced volumes. This usually indicates a strong downtrend. The most tempting shorts are in metals, banking and realty. Realty majors look weak and there is plenty of derivative volumes. In banking, PNB, Axis and Oriental look the best shorts and it is possible to hedge with long positions in the Bank Nifty. In IT, Educomp and Infy would be good shorts. In metals, Tata Steel could drop quite a bit. |
