If policy announcements beat market expectations either way, expect the key levels to be broken driven by volume expansion.
Despite range-bound trading and a lower VIX, there was nervousness evident as the market awaited key policy announcements. Open interest (OI) dropped and FIIs reduced their collective exposure.
Index strategies
Ahead of a key weekend when the government and RBI will announce policies, the Nifty futures OI dropped by 11 lakhs. FIIs, who normally hold about 37-40 per cent of outstandings also reduced exposures - they hold around 33 per cent of Friday’s OI.
The cutback is a signal of nervousness on the part of traders, both local and overseas. In addition, daily volumes have been low in both cash and derivatives market. Prices have been stuck within a trading range.
The fence-sitters are waiting for triggers. They will act after absorbing the policy announcements (after the time of writing). If volumes come in with a disproportionate seller/ buyer bias, the market will make a breakout in. This is likely to be sharp due to the thin trading over the past few weeks.
The market has repeatedly bounced on low volume between support above 2,500 and resistance above 2,850. It has consistently registered 150-point sessions without managing to break out. The effect of alternative up-down sessions has been a lack of trend.
The VIX has moved downwards from around 70, though it remains at a historically high level of 50-plus.This indicates implied volatility is still high. But, traders are somewhat less fearful than in October-November. In the past week, the market tested the upper end of this 2,500-2,850 range.
If there are big rate cuts from the RBI, or if the government comes up with proposals that the market likes, there could be buying volume coming in. In that case, resistance at 2,850 will be tested again and it could break quite easily. On the other hand, if the market is disappointed, heavy selling would break the support at 2,500.
There is of course, also the chance of a balanced volume expansion where prices stay within the trading range. This would happen if there was a mixed reception to the proposals. There is also the possible impact of geopolitical aftershocks from the Mumbai attacks or of follow-on attacks. This is frankly, incalculable since events could unfold in many directions.
Technical signals about possible future direction are mixed. Index futures traded very close to their underlying values. The BankNifty has been generating very high volumes – partly due to anticipated rate cuts and partly due to the rupee’s volatility.
The rupee has strengthened to above Rs 50, but it may be hitting resistance soon. A rate cut from the RBI would not necessarily have the linear effect of pushing the rupee down again even as relative USD-INR interest-rate-differentials narrow. In 2008, the currency has weakened 25 per cent due to continuous FII redemption and the erosion of over $50 billion in reserves. If the FIIs bring money in on a rate cut that could lead to the rupee strengthening even as the relative USD-INR rate-differential reduces.
The CNXIT also has respectable volumes and it is liable to move in the opposite direction to the BankNifty. If the rupee rises, IT will see a continuing sell-off while the BankNifty will rise. Vice-versa if the rupee falls.
The overall put-call ratio (0.8) remains low to neutral and in terms of OI, the Nifty’s PCR of 1.08 suggests that the market is mildly bullish. Incidentally, a lot of December Nifty puts were extinguished on Friday, while a lot of new calls were opened. So, the PCR has actually fallen. Carryover is quite low with 78 per cent of option OI in the December series.
This will be a relatively short settlement (December 24 or 26 since Dec 25 is a holiday). Traders will have to be prepared for a swing anywhere between 2,200 and 3,200 inside the next three weeks. If there is a breakout, one or the other of those marks could be hit.
There are several possible option-trading strategies. One is taking narrow vanilla spreads inside the current trading range. These are liable to be hit regardless of broad market direction. Another is the creation of short strangles on the assumption that there will not be a breakout and that positions can be held till expiry. A third strategy is long strangles on the assumption that there will be a breakout. The second and third strategies are mirror images of each other.
A narrow bullspread of long 2,800c (99.7) versus short 2,900c (64.25) costs 36 and pays a maximum of 64. A narrow bearspread of long 2,600p (96.4) versus short 2,500p (66.2) costs 30 and pays a maximum of 70. Both spreads offer decent risk:reward ratios and both could be hit easily.
A long strangle of long 2,500p and long 2,900c costs 130 and it can be laid off with a short strangle of short 2,300p (30.75) and short 3,100c (23.6). That would reduce the net cost to 75 and offer a maximum payoff of 125 on a breakout in either direction. The inverse position offers initial pay-in of 75 and maximum loss of 125. So, the risk:reward ratios are better for a breakout.
| STOCK FUTURES/OPTIONS Sectors could see a surge in volatility next week. Banks and real estate stocks will be major movers, up or down. There has been some speculation by long traders in beaten –down auto and capital goods/engineering and construction stocks. PSUs like IOC, BPCL, HPCL and ONGC have taken a hammering. IT will be counter-cyclical. L&T could be among the safest plays – it has good support below current levels and a potential upside till Rs 850. Keep a stop at Rs 710 and go long. |
