Hold on to existing shorts; play declines with put options

Nifty posted one of its largest weekly drops in the first week of the January expiry itself. The index could not breach the high made at the start of the week.

The fall intensified in the second half of the week. The drop could take away a lot of confidence as the premium on the Nifty January futures dropped from almost 50 bps to less than 15 bps towards the weekend.

The participation in the Nifty futures was augmented through the week by over 6%. This was mainly led by increment in open interest towards the end at lowering premium, indicating creation of fresh short position. Even the institutional activity saw net selling in index futures with rise in open interest.

On the stock futures side, the exposure still remains low as the participation has already seen a drop of 10% in the December expiry. The aggregate rise in open interest as far as stock futures is concerned remained rather low at 5%.

This was mainly due to unwinding in many of the longs carried forward from the last expiry. However, there were sectors such as banking and cement that saw a build-up of short positions during the fall last week.

Some of the speculative shorts were also seen in fertiliser stocks and even the real estate majors were not spared in terms of fresh short build-up. Similar trend was seen on the institutional side as there was net selling in stock futures with a rise in open interest.
As far as Nifty January series Options are concerned, the composition flipped last week. The Open Interest Put Call Ratio (OIPCR) which indicates the temperament of the market was favouring bulls at 1.6 at the start of last week. The deterioration in the index has moderated OIPCR to 0.9.

This was mainly due to heavy writing in higher strike calls in Nifty in anticipation of the recovery from the ongoing fall if any to be small and less fierce. Even the Implied Volatility (IV), which can be inferred as risk premium priced in options went up in last few sessions for Nifty.

This indicates assumption of greater risk of downside by the participants. The highest strike among the puts has shifted from 6000 to 5800 indicating post the breach of anticipated lower band of 6000, the participants’ next consensus support comes around 5800 levels.

Going forward, we feel the pressure may continue in the market given the macro uncertainties on the domestic front, which can also be seen from the developments on the F&O front last week. Some of the sectors such as banking and cement may continue to see pressure.

Hence, we advise to continue to hold on to existing shorts. The respite can only come through short covering rally if the shorts realise their intended levels. Considering the fact that we have already fallen meaningfully through the last week, we feel one should play the further fall using options via going long on put options.

Also, for fresh as well as existing positions one can create synthetic put option positions as well by having a short position in futures and going long on the call option of the strike nearest to the price of the stock.

The writer is manager-derivatives at Motilal Oswal Securities Ltd