Volatility could spike due to settlement

DERIVATIVES

There have been net gains across most of the F&O universe and the carryover trends look reasonable.

There is evidence of operator activity with the FII share of outstandings having shrunk to 40 per cent, while daily volumes have stayed above Rs 40,000 crore. Volatility was low last week and it is liable to rise nearing settlement.

There is likely to be at least one, more likely two, extremely volatile sessions because there will be a combination of 1) Traders covering losing shorts 2) Traders booking profits after last week's rally and 3) Traders carrying over (mostly long) positions.

This spike may actually be reflected in the VIX, which is trading below 30 - that level is very low. Unfortunately, we don't know enough about the VIX's fear (high-reading) and complacency (low-reading) levels to interpret its current reading with confidence.

If the current VIX reading of 27-28 is abnormally low, it is associated with an intermediate peak. In that case, we'd see a jump in volatility and a price-downtrend. But the VIX has simply not been in operation long enough to assert this.

In the index futures segment, carryover has started in the Nifty and the Bank Nifty where there is May open interest (OI) and liquidity. Premiums and differentials between spot and April-May contracts aren't much however.

The Nifty closed at 4,958 in cash and it was settled at 4,960, 4,965 and 4,963 in the April, May and June contracts respectively with 28.5 lakh April positions being closed and 16.5 lakh new May-June positions were opened. Obviously the difference is not worth trading.

The Bank Nifty closed at 7,165 in spot with the April contract settled at 7,159 and May at 7,167 with reasonable May liquidity. Carryover is apparent here. The CRR hike may cause excess volatility and a negative impact. It may be worth shorting the April contract and waiting till Wednesday to cover.

The CNX IT closed at 4,304 with the April contract held at 4,304 and May at 4,345, but there is only token May liquidity. The CNX Nifty Junior has no May liquidity and it was settled at 8,521 with spot closing at 8,573. In the Junior, a long future looks reasonable and in the CNX IT, short May and buy April if you get reasonable May quotes.

In the Nifty options market, approximately 28 per cent of all open interest is concentrated in May and June contracts. This is reasonable with four sessions to go. Assuming carryover is likely to be healthy, there is going to be a scramble in the next four sessions.

The current PCR (OI) for all nifty options is at 1.21, while the OI for May-June is at 1.17. These are normal and close to neutral ratios "� the May-June PCR is somewhat on the low side for this stage of settlement. This could be interpreted to mean a likely put OI build up and therefore, a fall immediately after settlement.

Technically however, the trader should be prepared for a move anywhere between 4,700-5,100. The expiry factor has to be balanced off against the fact that, as the VIX indicates, April options are cheap. Close to money positions can be taken in the April settlement with a fair chance of being hit.

A bullspread of long April 5,000c (48.7) versus short 5,100c (12.9) costs 36 and offers a maximum return of 64. A bearspread of long 4,900p (41) and short 4,800p (21.05) costs about 20 and pays a maximum of 80. Both those returns are decent and there would be a profit on either position given 100 points swing from current prices.

Combine the two spreads and the resulting long strangle "� short strangle position offers a return of 44 if either the upside or downside is fully realised for a cost of 56. Even with four sessions to go, this is quite a reasonable risk: reward ratio.

May spreads can be taken wider but they are naturally more expensive. A long May 5,000c (169.15) and short May 5,200c (79.55) costs about 90 and pays a maximum of 110. A long May 4,900p (163.55) and short May 4,700p (97.95) costs 65.6 and offers a maximum return of 134.4.

A wide strangle of long May 4,600p (77.2) and long 5,200c (79.55) costs about 157 and it can be laid off with a short May 4,400p (40.25) and short May 5,400c (35.95) for a net cost of 80.

The resulting position would pay a maximum of 120 on either an upside or downside breakout. This position therefore relies on a 10 per cent move in May, to fetch a potential return of 150 per cent.

On balance, the bearspreads have better risk:reward ratios in either April or May and these are worth concentrating on. The bullspreads have reasonable ratios, but this does seem to be a long-term bear market and the intermediate trend may not stay bullish for too much longer.

STOCK FUTURES/OPTIONS

Its results season and moves are necessarily stock specific. Orchid Chemicals is generating huge volumes and so is Infosys in the futures market.

HCC is another unusual stock, which is generating unusually large futures volumes - around 8 times as much as in cash. A "sleeper" could be Arvind Mills, which has seen a mini bull run in the past few sessions.

But, the really hot position could be TTML, where excitement on several fronts has led to a vertical spike. A long April or long May position could be quite rewarding, but keep a stop at Rs 32