Low volume cash trading was coupled to low-key activity in the derivatives segment. The FIIs cut derivatives exposure. Option premiums rose. A fair amount of index option volume migrated to the September series.
Index strategies
The VIX for what it’s worth rose last week. Although this is a flawed indicator, it does suggest that implied volatility is up. That’s surprising because historical volatility didn’t rise much as the market was range-bound.
About 40 per cent of index option open interest (OI) and around 5 per cent of index futures is already in September or beyond. This is somewhat higher than one would expect at this stage of the settlement with five sessions to go before full margins are imposed. The high carryover is useful in that it guarantees trading volumes are not likely to fall further.
A fair number of puts were cashed last week as well while the call OI increased. This has interesting implications. The put-call ratios (in terms of OI) are hovering near the danger zone. The overall index PCR and the September PCR are both at 1, while the September PCR is at 0.9.
Theoretically, 1 is the neutral point. Above 1 is bullish while anywhere below 1 is considered bearish. In practice, Indian bull markets seem to generate PCRs that are more likely to be 1.2 or higher. So my interpretation of the PCR would be somewhat bearish. This mildly bearish interpretation is backed by the fact that the liquid index futures are generally trading at small discounts to their underlyings.
This could mean that the market, which has range-traded between 4,359-4,619 in the past week, will continue to range-trade for the next couple of sessions. The Nifty is at the high end of this range and may well correct towards the lower end (as the PCR suggests) without changing either the intermediate or the long-term perspective.
Both the historical volatility and the implied volatility suggest that the Nifty will continue to generate daily 100-120 point high-low swings. Volatility could rise and is unlikely to drop. This means that it would take two trending sessions in succession to break out of the current range. If there is a breakout, a move till around 4,200 or till 4,750 (depending on the direction of the breakout) is equally likely.
One possible interpretation of the weak PCR and the behaviour of the Vix and technical signals is that the market will go into a free fall until it hits support at 4,200-4,250. Another interpretation is a slide till the 4,400 support, followed by recovery till 4,600 and then a breakout till the 4,750-4,800 level. The second is more likely if we look at intermediate and long-term signals, which seem to be bullish.
It is possible to make a case for both scenarios. So the trader should be prepared for moves between 4,200-4,800 – roughly 400 points down, or 200 points up. Note that there is expiry risk because these are significant swings, which could spill beyond the settlement (August 27). That could explain the strong carryover – some smart money is betting the breakout will occur post-settlement.A close-to-money bullspread like long 4,600c (101) and short 4,700c (61) costs 40 and pays a maximum of 60. A CTM bear-spread of long 4,500p (79) and short 4,400p (47) costs 32 and pays a maximum of 68. Note that the bull-spread is much closer to the money – the August Nifty future was settled at 4,575 on Friday.
A directional trader may prefer to go with the bearish possibilities because the bear-spreads have better risk-reward ratios. However, it is possible to construct two-way positions. A long strangle of long 4,500p and long 4,700c costs 140 and the net cost drops to 94 if this is offset with a short strangle of short 4,900c (18) and short 4,300p (28). This offers a maximum one-way return of 106 and the breakevens are at 4,406, 4,794. The expiry risk appears too high though the risk-reward ratio is reasonable.
A long future (with a stop loss at 4,525) can be coupled to a bear-spread of long 4,500p and short 4,400p. Similarly a short future with a stop loss at 4,625 can be coupled to a bull-spread of long 4,600c and short 4,700c. The long future and bear-spread position has a maximum loss of 82 between 4,500-4,525 with unlimited upside gain and a possible loss of 18 on the downside. The breakevens are at 4,418, 4,607. The short future and bull-spread carries a maximum loss of 65 between 4,600-4,625. It has unlimited gain on the downside coupled to a maximum gain of 10 on the upside. The breakevens are at 4,690 and 4,543.
These positions are more attractive simply because the breakevens are close to money and hence, expiry risk is much lower.
| STOCK FUTURES/ OPTIONS There are three potentially attractive sectors to seek stock futures positions. In each case, tight stop losses will be required. One of them is real estate because the majors have bounced back strongly last week. Here the trader could look for long positions in DLF, Unitech, HDIL or IBREL. The danger is that this upswing looked like a correction in an oversold sector and it may be unsustainable. The second attractive sector is oil and gas which seems to be bullish at the moment. Long positions in GAIL and Cairn could be worthwhile. The third attractive possibility is short positions in sugar stocks, which slid as a group on the news that free market quotas could be increased. The vulnerable F&O sugar counters are Balrampur, Bajaj Hindustan and Shree Renuka. The latter looks the most attractive in that it drop the most. |
