The Nifty is likely to stay inside the range of 4,300-4,500 unless there is a drastic change in sentiment that translates into higher volumes.
A low volume settlement that saw reasonable carryover was followed by a session characterised by short covering as prices shot up. However, in absolute terms, volumes in both cash and derivatives remained quite low.
Index strategies
The Nifty swung through 170 points in the last two sessions. However, despite a 4 per cent movement, implied volatility stayed low. The VIX eased down from 36 to 31. The FII alignment is puzzling. Since January, they have been heavy sellers but retained a large presence in derivatives, usually holding over 40 per cent of all open interest.
Over the August settlement, FIIs eased back derivatives commitments to around 35 per cent. Last week, they hardly traded cash segment at all in the first four sessions but they increased derivatives exposure to around 42 per cent of all open interest (OI). It is worth noting that FII exposure to index options has also increased in terms of overall exposure. This might mean that they are ready to buy again in cash as anecdotal evidence occurred on Friday.
The relatively low implied volatility and the short term uptrend on Friday could mean next week will start on a bright note. Nifty OI expanded by around 5 lakhs and the September series settled at 10 point premium to spot. The put-call ratio (in terms of OI) for Nifty options was in the range of 1.3-1.4 for different series and that is bullish and clearly an improvement from the 0.8 PCR available at the end of August settlement.
An interesting point is that around 40 per cent of all OI is now focussed in the December 2008 series and beyond compared to 55 per cent in September 2008. Obviously structured long-term products are becoming popular.
Last week much of the action centred on subsidiary indices rather than on the Nifty itself. Other indices are also running at premiums to their respective spot values. The BankNifty in particular is generating interest and so is the CNXIT. Both did well last week and were prime movers of the overall market.
On Friday, the market responded to unexpectedly low WPI numbers that drove up the beleaguered BankNifty. While the BankNifty has underperformed over calendar 2008 due to the trend of higher interest rates, it has also shown the ability to suddenly recover lost ground. As a result of violent moves in both directions, it is attracting a lot of volume and is now the most liquid of the subsidiary indices with over 4 lakh OI.
Given the volumes major banks attract in the stock futures segment, it is not surprising that there has been a spillover to the industry index. But all bank shares have a high, positive correlation with each other. So the BankNifty cannot be used efficiently as a hedge since every individual bank stock tends to move in the same direction as the index.
Anyhow the BankNifty continues to look as though it is making a bear-market rally and it would be dangerous to stay long over the whole of next week. Any rise is likely to be driven by private banks. The PSUs were the drivers last Friday and it could be the turn of privates to move up early next week.
The CNXIT responded to a trend of weakening in the rupee, which has dropped from around Rs 42.20 / USD in early August till around Rs 43.8. The RBI has generally intervened around the Rs 43.75 levels and such an intervention could abort the rupee slide next week. If the rupee does drop to Rs 44 or beyond, it would signal a change in the RBI’s float-strategy and that has wider implications. It seems unlikely.
The Nifty itself is likely to stay locked inside the range of 4,300-4,500 unless there is a drastic change in sentiment that translates into higher volumes. If the index does rise beyond 4,500, it would have to absorb very heavy selling. On a fall below 4,300, the support at 4,200 is likely to be tested and it might hold.
This view makes a strategy of narrow close-to-money option spreads seem optimal even though it is the beginning of a new settlement. In the options market, a bullspread with long 4,400c (130.8) versus short 4,500c (86.45) costs 43 and pays 57. A bearspread of long 4,300p (116.7) and short 4,200p (84) costs 33 and pays 67. Both these spreads could be struck and fully realised by the end of the settlement. The bearspread obviously offers slight better risk:reward ratio.
A strangle of long 4,200p and long 4,500c would cost about 171 and it could be laid off with a short strangle at short 4,000p (39.25) and short 4,700c (28.65), which cuts the net cost to about 103. The combined position still doesn’t quite work in terms of delivering satisfactory risk:return ratios and a move till either end of the 4,000-4,700 band before September 25 looks slightly against the odds.
A bearspread with long Aug 4,300p (50.5) and short 4,200p (22.5) offers a maximum return of 72 on a cost of 28. A bullspread of long Aug 4,400c (33.65) and short 4,500c (12.7) costs 21 and pays a maximum of 79. There isn’t much difference in the risk-reward ratios for August. The bearspread is closer to the money but the bullspread has the better risk-return ratio.
A wider set of positions can be constructed using mid-months. A bearspread with a long Sep 4,200p (126) and a short 4,000p (70.55) costs 56 and pays a maximum of 144. A bullspread with a long Sep 4,400c (131.35) and a short 4,600c (57.8) costs 73 and pays a maximum of 127. At longer timeframes, the bearspread has a better risk-reward ratio.
My gut feel is that it’s not worth looking at September yet. Accept the expiry risks and stick to August. There, it’s a toss up between bearspreads and bullspreads. As of now, straddles and strangles also look uncertain. The index appears range-bound and straddles and strangles only make sense where a big move is likely.
| STOCK FUTURES/OPTIONS Apart from IT and Banking, stock movements have been quite random last week. Rather than industry specific factors, stock-specific factors seem to be paramount at the moment. One interesting situation is Tata Motors – the stock has remained stable despite Singur being continuously in the headlines. |
It is tempting to suggest a short position in case the Tatas decide to relocate. If you decide to short Tata Motors, keep a stop at Rs 445. Another possibility is a long position in Renuka, which could bounce next week. A long Renuka would need a stop loss at Rs 112.
