Selling strangles outside the zone of expectation or a long call butterfly are some options to exploit the low-volatility situation.
Another low volume, low volatility week ended with net losses. Most of the major operators and the FIIs appear to be in holiday mode.
Index Strategies
The December settlement is likely to be low volume and low carryover. Historical volatility in the past two weeks was well below normal with the market's daily high-low range dropping to below 1 per cent. Despite net losses, option premiums reflect this low volatility with the VIX dropping.
Daily volumes in F&O have dropped well below normal levels as well. The disinterest on the part of FIIs is expected due to the year-ending and festive season. But it seems Indian operators have also cut back. For what it's worth, FIIs continue to hold around 35 per cent of all open interest (OI). Carryover patterns are also on the low side of normal. About 15 per cent of Nifty futures OI has moved to January-February along with 35 per cent of option volume having moved beyond the December 2009 settlement. OI has dropped. It seems most operators and traders will wait until FIIs reveal their 2010 stance.
The CNX IT and the Bank Nifty are heading in opposite directions. The Bank Nifty has lost a lot of ground and been a drag on the overall market. T-Bill yields rose in the latest RBI auction, confirming tight liquidity. The CNX IT on the other hand, has outperformed the market. It is in fact, the best performing sector of 2009. The rupee continues to look weak.
It is possible that these two trends of weak Bank Nifty and strong CNX IT will continue. The Bank Nifty may however, bottom fairly soon since its testing support. Since banks are high-weighted in the Nifty itself, a serious Nifty bounce is likely to be driven by a technical recovery in the Bank Nifty. Both the indices have seen a marked increase in OI though the Bank Nifty of course has several multiples of the CNX IT's volumes.
The Nifty itself has seen low volatility to the point where it is difficult to take trading positions. It is trading inside a zone of major congestion, meaning there is plenty of previous high volume trading history at current levels. Until volumes improve, a major move is unlikely. Until the FIIs increase participation either as buyers or seller, volume is unlikely to improve. So, the index is likely to stay stuck near current levels though there will be a likely downwards drift due to lack of demand. We may see this pattern of narrow range-trading continuing until early January.
There are two weeks to the settlement. Option put-call ratios are in the normal range of bullish or neutral. The option chains suggest that trader expectations are clustered very close to the money. The put option chain has most of the OI at 4,800p (27), 4,900p (51) and 5,000p (90) while the call chain has most of the OI clustered at 5,100c (36) and 5,200c (15).
It should be noted that the market slid below 5,000 only in the closing minutes of Friday, hence, there is a large amount of in-the-money OI especially in the put. There is still a fair amount of OI at the 4,500p (4) so some pessimistic hedgers are around.
One temptation in a low-volatility situation is to sell strangles outside the zone of expectation. Assuming the market stays range-bound, the trader can probably sell say, the 4,700p (13) and the 5,200c (16) and swallow the premium. He could lay off this position by buying the 4,600p (6) and the 5,300c (6) to reduce the risk from theoretically unlimited to a maximum loss of 83 on a one-sided movement. Such a combined short-long strangle would pay a maximum of 17 and it would be profitable if the market stayed within 4,683, 5,217.
Another way to exploit low volatility would be a long call butterfly. The profits could be higher and downside is limited. It involves high margins and commissions. In the butterfly, the trader takes an in-the-money long 4,900c (135), sells two 5,000c (76x2) and buys another long 5,100c (36) for a total cost of 19. If the market is below 4,900 at expiry, the initial payout of 19 is the maximum loss.
If the market is between 4,900 and 5,000 at expiry, the two short 5,000c and long 5,100c expire. The gain is the intrinsic value of the 4,900c, which is a maximum 81 at 5,000. Between 5,001 and 5,100, the long 4,900c offsets losses on one short 5,000c. The overall profit drops, as losses on the other short call increase. The maximum loss of 19 is at 5,100. Then the downside is capped by the long 5,100c. Apart from this complex possibility, standard bullspreads and bearspreads close to money offer decent risk-return ratios. A bullspread of long 5,100c and short 5,200c costs 21 and pays a maximum of 79. A bearspread of long 4,900p and short 4,800p costs 24 and pays a maximum of 76.
A combination of these two positions would cost a total of 45 and the resulting long-short strangle is worth examination. It yields a maximum return of 55 if the market hits either 4,800, or 5,200. If it hits both (not likely), the return would be around 155.
| STOCK FUTURES/ OPTIONS There are quite a few shorts available in the banking and realty sector. Axis Bank and ICICI Bank are likely to move more than the Bank Nifty in the same direction and this is also true for IFCI. DLF and Unitech are also looking weak. On the long side, a position in Cipla or Sun Pharma may work. In IT, TCS and Infosys are both looking good. Hindalco and Suzlon are also looking fairly strong. Another possibility is a long position in Essar Oil, which shot up on Friday. |
