Intermediate trend has been up for eight weeks and may be close to maturity.
The market swung through a 200-point range and ended at the low end. Volumes improved slightly. Volatility and implied volatility remained low.
Index moves
Sentiment weakened dramatically on Friday after there were net gains on Wednesday. There were several macro-economic triggers early in the week. Crude prices kept falling and WPI came down slightly. The rupee slid below Rs 44.3 and stayed there without any sign of RBI intervention. GOI T-Bill yields dropped slightly.
On Friday, the global cues got less positive. The FIIs continue to hold around 38 per cent of outstandings but they continued to be net sellers in cash.
There was reasonable open interest expansion across the index futures and index option spaces. The Bank Nifty and the CNXIT both showed positive returns although they were weak on Friday.
Both these sector indices have decent OI - the Bank Nifty holds almost 5 lakh. The futures are trading at some premium to the spot. That is true for the Nifty as well, where the September futures is at a premium of 14 points to the spot. The Junior is also trading at a large premium to spot but it has unsatisfactory liquidity.
The Bank Nifty could be vulnerable since the inflation levels are high and there is a good chance that rates will harden again. The CNXIT is less vulnerable since the rupee weakness appears to be secular. In the banking sector, the PSU banks have been more enthusiastically backed by bulls and action in the private bank has been more muted.
The IT sector is at the mercy of possible RBI intervention. It's possible that the RBI may let the currency depreciate somewhat but any intervention will trigger a drop in the CNX IT. Action in the new currency trading segment suggests that market expectations are in the range of Rs 44.80 to the dollar by the end of the month.
For the past couple of weeks, the market has been stuck inside a trading range and lower volumes are quite normal under such circumstances. The intra-day ranges have also not been particularly high.
Hence the volatility has been low and the VIX is also trading on relatively lower at 32. The put-call ratios also give us little sense of direction since they are in normal zones with the overall Nifty PCR being around 1.3. Some puts were cashed out on Friday but the overall OI has continued to expand.
The chances are, volumes and volatility will both spike with a breakout. We can define breakout limits reasonably well as either below 4,150 or above 4,650. But we don't have a clear time signal for a breakout. This is a short settlement and it is possible that the market will just maintain a trading range until September 25. However, the odds are, there will be a breakout before that and the probability of a downside break is somewhat high. The intermediate trend has been up for eight weeks and it may be close to maturity.
The chance of a breakout and of a possible transition to a bearish intermediate trend makes strategy difficult. Should the trader look at wide strangles that can gain only on breakouts? Or should he stick to small spreads that are close to money?
A long 4,200p (76.1) and a long 4,600c (49.25) are both reasonably far from money. Covered with a short 4,000p (33.75) and short 4,800c (14.85), the net cost of such a combination of strangles would be about 77 and the breakevens come at 4,123 and 4,677 with a maximum gain of 123 if the market moves to the limit in either direction. To put this in perspective, it would require three strongly trending sessions for this position to work. This looks reasonable.
A more conservative strategy is the normal close-to-money bearspread or CTM bullspread. A long 4,300p (109.4) and short 4,200p (76.1) costs 33 and pays a maximum of 67. A long 4,400c (121.7) and short 4,500c (79.4) costs 43 and pays a maximum of 57. The bullspread is marginally closer to the money.
Both spreads have reasonable risk-reward ratios and both are very likely to work, perhaps within a session or two.
Since the CTM spreads are reasonable, there is no necessity to be creative and shoot for a breakout. But be braced for the possibility and don't sell deep out-of-money calls or puts, which will be dangerously exposed on breakouts.
| STOCK FUTURES/OPTIONS If you trust the optimistic projections about further drops in crude prices, the PSU refiners and marketers could offer good long positions. There has already been quite a bit of speculative action in these stocks. Among banks, PSUs such as Syndicate Bank, SBI and Oriental Bank look more attractive than those in the private sector. In IT, the trend is quite mixed. |
The auto sector's collective movement may depend on the outcome of Singur negotiations. Either way, Tata Motors is likely to harden because the downside of a likely pullout has already been discounted but other auto stocks will react badly on a pullout. Metal stocks are all looking weak. A short Sterlite or a short Tata Steel looks tempting.
On a short Sterlite (Rs 592) keep a target of Rs 565, and a stop at Rs 602. On a short Tata Steel (Rs 563), keep a stop at Rs 570 and a target of Rs 530.
The telecom sector is interesting. Listed private TSPs saw selling down to reasonable supports but MTNL was bullish through the early part of the week. The trader could look for a "paired" strategy of long Airtel and short MTNL assuming some mean reversion to the "normal" difference between the two stocks.
