Open interest has risen along with a north-bound market although overall derivative volumes remain moderate. The FIIs have reduced their commitments. Strangely, implied volatility hasn’t changed at all despite the breakout.
Index strategies
The breakout above Nifty 2,850 last week set up a 10-15 per cent upside target for the main market index. Time-projections suggest a frame of 3-5 weeks. An established trend and that usually brings in more traders. Overnight positions also become more attractive. Hence, both volumes and OI tends to rise on a breakout.
It’s also normal for IV to drop when the market is in a trading range because the historical volatility usually drops in these circumstances. So, HV is also often seen to rise along with a breakout and this is usually mirrored by a rising IV.
There hasn’t been an overall volume expansion in derivatives though cash volumes have risen slightly. The prime reason is that FIIs have consistently reduced their derivatives exposure in the past three weeks even though they have also changed their cash market attitude from net sellers to net buyers.
Nor has IV changed. The VIX has remained stable at around the 51 level, through the last phase of range-trading and then, the breakout. Of course, 51-level is objectively quite high and suggests that the market will see plenty of movement.
Instead of holding the 38 per cent of all outstandings that they have averaged in 2008, the FII derivatives commitment is now down to around 31 per cent. The probable reason is the Christmas break. If the FIIs maintain their December trend of net buys into 2009 and come back refreshed after the New Year, there will be significant volume expansion at that point of time.
But that’s in the next settlement. Right now, it’s up to Indian traders and operators to carry the slack and they don’t have too much money power at this instant. We may see a pattern of consolidation close to current trading levels rather than a direct climb until such time as FII volumes return.
Most of the signals are either neutral or bullish. Futures of the Nifty and the CNXIT and BankNifty are trading at small premiums to the underlyings. OI is healthy in all of these. The rupee appears to be strengthening – FIIs turning net buyers would undoubtedly have helped here. Rupee bond market and T-Bill yields have dropped dramatically - a clear signal that interest rates will travel down.
In those circumstances, the BankNifty is definitely a buy and the CNXIT remains a sell. The technical chart patterns on both these indices and on their major components also suggest that is the case. IT majors are mostly sliding down while the PSU bank sector and other rate sensitive stocks have seen sharp increases. Obviously currency traders will want to be short on the USD as well.
In the Nifty options market and indeed the stock options market as well, the put-call ratio has turned firmly bullish. Overall PCRs are around 1 while the Nifty PCR in terms of OI is around 1.3. However, there hasn’t been much carry-over yet with only 21 per cent of option OI in January 2009 and beyond. Since the settlement week is truncated, there could be a lot of action in the last three sessions.
The breakout allows traders to assume that there isn’t a great deal of downside and adjust their strategies accordingly. The most likely scenario is a continued rise till 3,200 levels. There is a good chance of consolidation between 2,750-3,000 and some chance of a failure that sees a reversion to range-trading between 2,500-2,850. So the focus range is between 2,500-3,200.
Bullspreads and bearspread close to money both have very good risk-reward ratios. A bullspread of long 3,000c (77.3) and short 3,100c (42.75) costs 35 and pays a maximum of 65 while a long 2,900p (101.3) and a short 2,800p (67) costs 34 and pays a maximum of 66. The bearspread is marginally closer to the money but both spreads could be hit next week.
Slightly further away, a long strangle of long 2,800p (67) and long 3,000c (77.3) can be capped with a short 2,500p (18.65) and short 3,300c (9.5). This costs 105 and pays a maximum of 195. While the ratios are good, the danger with the strangle combo is that the bulk of the movement may occur in the January settlement.
| STOCK FUTURES/OPTIONS On the short side of the stock futures market, the best possibilities are in the IT sector. Highly liquid scrips like Infosys, TCS, Wipro, HCL Tech and Satyam all look to be travelling down. So does Dr Reddy’s although the rest of the pharma sector appears firm. |
On the long side, there are more possibilities. Banks and rate sensitive stocks in engineering, auto and real estate could remain an excellent play. PSU banks are liable to outperform their private counterparts and there could be opportunities in DFIs like IFCI, IDFC and PFC as well.
PSU oil-marketers are also looking strong because crude has continued to travel down after the last retail price cuts and BPCL and HPCL have ample liquidity. There are also possibilities across both the Reliance and ADAG groups where there are half–a-dozen liquid plays that are all looking bullish. Here Reliance Industries, RComm, RIIL and RNRL look interesting.
Another possibility is Praj Industries which is seeing the sort of volume-price rise combination that often presages a big upmove. Keep a stop at Rs 61 and go long with an intra-day target of Rs 75-plus.
