Keep the shorts, but ensure tight profit protection

Nifty opened last week on a weak note, marking the high in opening trades itself. It was a topsy-turvy move that took the index to its lowest level since mid-September.

The fall could really squeeze the confidence out of long traders as the dismal premium on Nifty January futures at the start of the week vanished amid the fall.

The rally midweek did see some bit of short-covering in futures but it proved momentary as the shorts got reinstated in the fall of the last couple of sessions.

Nifty futures on an aggregate basis saw an addition of 2.9 million shares last week, which is more than 10% augmentation in participation. This indicates pessimism.

Stock futures position continues to remain light as we are halfway through the expiry and still below 2 billion shares in open interest. This is relatively lower compared with what we have seen in the last couple of expiries.

Week over week, there is no great change in stock futures open interest. This was mainly because, just like the Nifty, even stocks saw many shorts being covered and reinstated. The majority of action last week remained in rate-sensitive sectors such as banking, auto and real estate; the engineering sector saw some pessimists entering as well.

In banking, the pressure that could be seen only on public sector spread to private banks too, as indicated by the reduction in open interest in public sector banks and a rise in that of private banks.
Also, there was activity seen in metal stocks as steel shares added participation through the fall last week.

On the options front, the Nifty January series saw pessimism mounting to one of the highest levels seen in recent times as the open interest put call ratio (OIPCR), which indicates the sentiment of the market, went down to 0.71.

This suggests an overly pessimistic market, which is mainly led by aggressive additions in relatively higher-strike-call open interest, where the writers (sellers) are betting those strike prices will not be surpassed by Nifty.

On the other hand, the relatively lower but similarly heavy strike on the puts side for the January series is 5600, indicating anticipation of the same to be held till the current expiry.

Even implied volatility (IV), which can be used as a standard risk measure priced into options, has risen around 3%.

Going forward, it is evident that weakness still persists. However, as some derivatives signals such as the lowest OIPCRs and the highest implied volatility indicate, we may see a slowdown in decline.

A large number of participants in 5600 puts is indicative of such anticipation.

We do not advice exiting shorts, but one would be better of tightening the profit-protection levels to the nearest hurdles on the upside.

Fresh traders can, as the Nifty nears its potential technical support at 200-day daily moving average or DMA, deploy the long strangle / long straddle strategy.

Historically, potential supports and resistances attract a lot of volatility.

Hence one would make money out of the choppiness in the event of a sharp pullback from the 200 DMA or follow-through selloff upon breach of the same.

The writer is manager-derivatives at Motilal Oswal Securities Ltd