Markets stuck at 3450-3475 range

DERIVATIVES

A breakout that clears the 3500 level could leave the Nifty with an upside till around 3625.

The market continued to register gains without making a decisive move past a big resistance at Nifty 3450-3500. There was an improvement in sentiment on Friday. Most of the background signals were positive, but volumes remained below par despite an improvement.

Index strategies
The market is interestingly poised after a week of narrow range trading, which persistently tested the 3450-3475 without breaking it. A breakout that clears the 3500 level would probably leave the Nifty with an upside till around 3625. On the other hand, if the market falls from these levels, it will probably land around 3325.

The spot Nifty closed at 3471 with the September Nifty future held at 3471, while October Nifty was at settled at 3467 and November at 3465. Open interest has expanded in all three futures contracts though its still low in November and likely to stay that way until close to settlement.

The differential between the futures spreads are less than normal at the moment. If you wish to exploit this, you will need to take a calendar bullspread with a long September, short October combination.

That calendar spread would gain if the October contract went into greater discount. It's normal for the differential to be 10 points or more at this stage of settlement. Also the margin on this position is low. It will work in practice, if there's a breakout.

Of the other two tradable indices, neither performed well last week. The Banknifty was held at 4658.5 in spot and 4662.6 in the September futures. The CNXIT was at 4425.5 in spot and 4441 in the September futures.

It's difficult to make a call on the likely direction of movement of these two indices "� trading sentiment has been scattered and non-sector-specific.

Certainly, there are no arbitrage positions. As usual, there is insufficient liquidity in the October and November segments to offer calendar spreads.

In the Nifty index options segment, OI continues to expand across both the puts and calls. The Nifty put-call ratio remains at around 1.34, which is close to where it's been for several weeks (if we adjust for the chaos of settlement). By definition, this should mean that the options market is somewhat oversold and gains are rather more likely than losses.

A normal Nifty bullspread with long 3500c (59.4) versus short 3550c (35.7) costs 24 and pays a maximum of 26. This is not a very attractive ratio in terms of risk: return. An "in-the-money" spread with long 3450c (88.55) versus short 3500c (59.4) costs 29 and pays 21.

In effect, at current spot, this position loses 8 and pays a maximum of 21. An in-the-money bearspread with long 3500p (88.2) versus short 3450p (67.3) costs 21 and pays a maximum of 29.

That's obviously a better ratio. If we look for an out-of-money bearspread with long 3450p (67.3) versus short 3400p (50), the position costs 17-18 and pays a maximum of 32-33.

Obviously the bearspread ratios are considerably better and this reflects market expectations of a further rise. Given that these positions are all close to money, it is possible that the bearspreads would be struck even in a scenario of net gains.

There is also a fair chance that the market will go through another decline before settlement. So, I think the bearspreads are currently preferable positions despite the upside bias of the Nifty.

In a scenario where a breakout could occur in any session, strangles are very tempting positions. A long 3500c (59.4) and long 3450p (67.3) costs about 127. It would start offering profits if the market moved beyond 3325-3630.

These are the limits of our outer expectations however. We can cap this position on the downside with a short 3300p (25).

But there is zero liquidity in the call-option chain beyond about 3570 so we cannot create a full-scale short strangle. The partially covered position would start offering profits if the market moved beyond 3350-3600 but the risk:reward ratios are poor.

Summing up the index position, a combination of long Nifty future and bearspreads would probably be the best way to take care of movements in either direction.

STOCK FUTURES/OPTIONS

Trading sentiment has been scattered randomly across several sectors with no obvious biases. One expectation is that the rupee will strengthen further, given that the Fed is not taking aggressive action.

This could mean pressure on IT stocks and indeed, Infosys showed signs of a sell-off. The minor drop in the price of crude could also lead to a speculative rise in refinery stocks. It has already resulted in a jump in Jet Airways.

But the bulk of the action is likely to occur selectively across the board without sector biases. A few IT stocks may move up even if the rupee rises. Patni Computers and Polaris Software are both looking quite strong and may be worth long futures positions.

Among other stocks Bharti Airtel, Bhel, Grasim, Hero Honda, Hindalco, Maruti, NDTV, Oriental Bank, Reliance Energy and Sterlite all look strong. Long futures in any of these could work.

Century Textiles is an interesting case. The stock has developed good OI and the futures price of 497 is at a distinct premium to the spot of 489.

Tata Motors also shows a similar pattern with a futures price of 905 versus a spot of 897. Sterlite and Tata Steel have similar pattern of futures premiums. Arbitraging this is impossible unless you hold delivery but it could mean sharp rises for the counters mentioned above.