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Saturday, July 11, 2009

Derivatives: Market seems oversold, however volatility may continue


Many short positions were built-up in front-line index components, and any positive trigger from the corporate results may result in short covering and facilitate recovery in the index

An extremely disappointing budget that was presented on Monday 6th July 2009 by the Finance Minister Pranab Mukherjee completely reversed the market mood. Although there were some promising measures in terms of rural infrastructure and growth announced during the union budget, the government did not give any clear road map. Besides the fiscal deficit for budget year 2009-2010 was estimated to be around 6.8% without giving any concrete road map to bring down the same. The consequence was that the S&P CNX Nifty corrected 258.55 points or 5.84% on the budget day. After that the market remained extremely volatile throughout the week thus correcting by 420.35 points during the week ended 10th July 2009. Fresh short in some of the front-line stocks futures besides Nifty were witnessed throughout the week.

Equities dropped last week on concerns of a ballooning fiscal deficit and disappointment that the Finance Minister did not announce major liberalization measures in his new budget. A cautionary statement on India's sovereign rating by Standard & Poor's (S&P), the credit rating agency, further weighed on Indian market. S&P has a BBB-minus rating on India's foreign currency long-term debt, the lowest investment grade. Any fresh downgrade will rank India as 'junk', or non-investment grade status.

Some of the Nifty components added significant shares in Open Interest (OI) with fall in prices during the week, thus indicating fresh short being build-up in these counters. For e.g. for the full week ended July 10, Reliance added 7.11 lakh shares in OI, whereas Tata Steel added 8.30 lakh shares in OI. Other major counters like Unitech, ICICI Bank and Sail added 12.1 lakh shares, 8.49 lakh shares and 25.79 lakh shares in OI respectively. Rcom on the other hand shed 10.91 lakh shares in OI for the full week ended 10th July.

Nifty near month contract added 8.45 lakh shares in OI on 10th July owing to which the OI for the full week added nearly 5 lakh shares.

The most negative has been that the Nifty near month future traded at a discount to the underlying throughout the week and on Friday it closed at 10.20 points discount to the underlying. On Friday the Nifty spot fell 77.05 points to close at 4003.90 due to sudden selling towards the end of the day.

In the option segment the Nifty 4400 and 4300 call witnessed significant call writing on the budget day combined with aggressive put buying of 4300 strike. Thus the bearish outlook continued throughout the week with the most active strikes being 3800 to 4300 levels for both the puts and the calls. On Friday (10th July 2009) there was aggressive call writing at 4000 and 4100 strikes. Both these strikes added 5.77 lakh shares and 9.86 lakh shares in OI. On the other hand the same strike puts witnessed winding of OI during the day. Both these puts shed 3.41 lakh shares and 2.72 lakh shares in OI

The index put call ratio was 0.88 on 10th July 2009 as compared to 0.89 during the previous trading session, whereas the stock put call ratio increased to 0.36. Thus the market wide put call ratio was 0.85 as compared to 0.86 on 9th July 2009.

The week gone-by has been extremely disappointing for the market as it seems to have over reacted to the budget. The market is expected to remain volatile in the coming week as well as some of the front-line companies like Larsen and Toubro, HDFC Bank, and Axis Bank will declare their 1st quarter results. Although India's industrial output rose by a higher-than-expected 2.7% in May 2009, the ongoing monsoon development will be closely watched as more than 60% of farms output depends on the monsoons. The International Monetary Fund on Wednesday, 8 July 2009, raised India's growth forecast to 5.4% for 2009, even as it projected the world economy to shrink by 1.4%. In April 2009, it forecast a growth of 4.5% for India. The market seems to be oversold though, now since many short positions are built-up in some of the front-line index components, any positive trigger from the corporate results may result in short covering thus enabling the index to regain the lost ground.