More correction likely, volatility may rise

Markets are heading towards 5400 and this support will be challenged this week. But before we get into nitty-gritty of futures and options data, we would like to make certain observations which suggest us that it’s tough to get liquidity into our markets in near future.

If we look at yields of 10-year government securities in the US, they have been declining. From April 8, 2011 to June 10 yields have come down from 3.577% to 2.969%. In December 2008 they had fallen to 2.053% and recently in October 2010 they were at 2.392%.

As Federal Reserve chairman Ben Bernanke’s statement suggests that economic recovery is frustratingly slow, we expect yields may further correct from the current levels. If this happens it will certainly turn the money flow back to the US treasury in big way rather to emerging market equities which have numerous headwinds to deal with on the macro front.

There has been a fall in yields, there has been a sudden spike in two sessions in the dollar index from 73.521 to 74.795 levels. This has also resulted in fall in commodities across the board.

Coming back to internals of our market, Nifty futures week-over-week have reduced open interest by 3.46% and prices have reduced by 0.71% to 5484.15 levels. In the same period, FIIs have sold index futures worth `1,110.80 crore and their corresponding open interest has reduced by 2.41%.

This clearly indicates that correction was due to long unwinding in Nifty. We are also witnessing unwinding in most of the put options except 5400 and build-up in calls which has resulted in decline in put-call ratio open interest to 1.23 levels.

Friday, which had intraday volatility of 64 points in Nifty spot, was the most volatile day of the week. We also witnessed interesting activity in 5500 strike call and put on that day.

Call added 27,330 contracts while put reduced 26,153 contracts in June series. For us, this means that in the narrow range of last week where 5500 was acting as support is now resistance for this week, though not very strong. Implied volatility of option is still low and may now see substantial jump from the current levels of 16.71%.

We continue to recommend buying at-the-money put options as we expect markets to correct further and IVs to rise.

We have seen counters like Hindustan Unilever, Bharti Airtel, L&T, ICICI Bank and SAIL correcting due to long unwinding in the week gone by. Fresh shorting cannot be ruled out in them.

Counters where we have witnessed substantial formation of short positions are Hindalco, IDFC, Wipro and PNB. Some of the liquid names which outperformed last week such as Infosys and IVRCL Infra have risen due to short covering. Wait for formation of long positions before jumping into them.

The writer is head - equity derivatives at Angel Broking