Derivatives: Congestion at 5600-5700, put-call ratio favours bulls

The week that started with a lot of uncertainty over Union budget and concerns of geopolitical tensions ended with fair amount of relief leading the Nifty to one of its largest weekly gains in recent times.

We started off with a very light position in Nifty participation as the market awaited the Budget to take a fresh directional move.

However once the event was over,  the optimism was quiet obvious as the participants bought into every dip during the week as indicated by rise in the Nifty open interest by over 16% last week coupled with rise in the premium during week to almost 50bps alongside the rise in underlying index.

Stock futures also started the week on a light note but with the sector specific build up and unwinding started post the budget. Many of the stocks had pessimism built into it as we entered the week of budget.

The auto sector saw unwinding of shorts and fresh build-up of long positions as the budget came with positive surprise for the same, public sector banks stocks clocked additions of fresh longs last week.

Major increments were also seen in some of the cement and metal counters, which added more longs than shorts through the week.

Just like the Nifty, the stocks also saw more aggression on the long side as the average cost of carry (premium / discount) went up week over week with increments in underlying stock prices and open interest.

On the options front, the premiums on Nifty March options saw fair bit of spike on the first day of the week. This was led by the higher implied volatility (IV) factor, which was pricing in the risk of uncertainty caused by the event.

The IVs did taper off during the course of the week as the risk of down side started to coming down. However, we are still trading with higher IVs compared with the same period in February, which is justified by the choppiness that we saw even in the second half of the week.

As far as the option composition goes, the open interest put-call ratio (PCR) at 1.32 remains tilted in favour of bulls.

The Nifty may, however, find fair bit of congestion around 5600-5700 as anticipated by the large participation at the said strikes.

With higher IVs and the resistance band in proximity, we feel one needs to be a little cautious in taking fresh longs - place them, if you will, with appropriate protection on the downside.

One can protect long trades by going long simultaneously on put strike nearest to the price. Another way to play long at this juncture is through bull spreads, where one buys a call of the strike nearest to the current price and simultaneously goes short on the call option on the same underlying with the strike which is nearest to the intended trading target.

This lets one play with a known-loss strategy and reduces the loss of premium due to time decay.

The writer is manager-derivatives at Motilal Oswal Securities Ltd