The Hindu Business Line : Markets up for a volatile week

As far as stock markets are concerned, we are back to square one. After witnessing a sharp and rather convincing rally the previous week, our bourses have given away most of those gains over last week. Nifty futures weakened by four per cent to end at 4945.2 as against the previous week’s close of 5152.3. The only silver lining was the rollover figures. The week saw a rollover of about 32 per cent for the Nifty futures as against the market-wide rollover of about 28-30 per cent. These suggest a healthy trading interest in both Nifty futures and the overall market.

Market wide open interest, however, saw an interesting trend. The open interest positions, which saw steady additions over the week, petered out during the last two trading sessions. This could be due to offloading of positions by some of the FIIs. Open interest now hovers around Rs 80,000 crore.

Follow-up

We had presented two strategies last week.

Going long on Nifty future keeping the stop-loss at 4950; and

Considering long strangle by buying Nifty 4700 put and 5500 call.

The first strategy would have failed and hit our stop-loss, as markets tumbled sharply last week. The second, however, would be marginally out of money. While long straddles are best suited for uncertain times, the strategy failed to deliver this time around because of the decay in time value (as the May contracts are nearing expiry).

Outlook

We expect the Nifty future to witness significant volatility in the forthcoming week. As we have always maintained, the Nifty future faces a strong resistance at 5350, a level it failed to breach last week also. It is now loitering precariously close to its support at 4950. Failure to sustain at this level will take Nifty future to its next crucial support at 4400. However, any reversal from the current level holds the potential to take Nifty future first to 5150 and then to 5350 levels. However, for the overall negative bias to lift, Nifty future has to make a decisive move above 5850, failing which the probability to revisit its January lows looms large.

Recommendation:

Since we are now approaching the settlement week for the current month derivatives contracts, volatility is sure to make its presence felt. The risk-return payoff during such volatile times, more often than not, favours the use of straddles. Traders can consider setting a straddle for Nifty. You can do this by buying Nifty 5000-June strikes for both call and put options. Note that this is a good strategy when you feel that there will be a large price movement in Nifty in the near future but are unsure of which way that price movement will be. The premium paid for setting this option spread is the maximum loss you can suffer while the gains can be unlimited should the price move sharply in one direction. Nifty 5000 call on Friday closed at Rs 150.70 and the put ended at Rs 214.65. Traders can consider holding this strategy beyond this week.

Implied volatility

Implied volatilities for puts remained firm at about 30 per cent against last week’s 31 per cent. However, calls IV increased to 30per cent (27 per cent). The firmness in the put IV suggests that many traders could still be holding on to put options expecting a further fall in the market despite last week’s sharp downslide.

Put/call ratio

Volume wide put/call ratio decreased to 1.08 (1.25) and the open interest PCR fell to 1.33 (1.44).The decrease in volume interest PCR could be due the low level activity in Nifty on Friday.

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