This likelihood of short covering leads us to expect another big plus session sometime next week.

This promises to be a humdinger of a settlement with loads of volatility and high open interest and carry over. You can make a logical case for the market moving in either direction – in fact, you can pretty much guarantee that it will move sharply in both directions before it shows a clear trend.

Index strategies

The spot Nifty closed at 4190.15 on Friday with the August contract being settled at 4177.95 while the September contract was settled at 4161.55.

The Nifty Junior and the Bank Nifty were the only other liquid indices with the Junior spot closing at 7982 while the August future closed at 7965 and the September future was settled at 7968. The Bank Nifty closed at 6176 in spot while it was settled at 6190 in theAugust future and 6223 in the September future.

This is a narrow market but a very liquid one- there are almost 4 crore open contracts on the Nifty – of these, over 9 lakh contracts are already open in September. The market is clearly expecting a further fall if one goes by the differentials. Since the spreads must align on settlement, a long September- short August would lock in a reasonable profit.

The FII position is interesting. On Friday August 17, F&O exposure was rising and the bulk of additional positions were short Nifty and short stock futures coupled to long Nifty calls. Their spot attitude displayed heavy net-sales.

In the last two sessions, FIIs have been net buyers and on Friday August 24, the composition of F&O exposures had changed. New positions are heavily skewed towards put options or covered call sales along with long index futures and long stock futures.

To me, this suggests the following. The FIIs were net-sellers through the week ending August 17, and they pyramided sales with short index and short stock futures. They hedged with long calls in case the market jumped in the wrong direction.

As of now, they are buying back and booking profits in short F&O holdings. They are now hedging with long puts in case the market falls further. The ones who get the timing right will end up with cash profits as well as a lower-cost stock portfolio.

However, this is an analysis of aggregate attitude. Plenty of FIIs are holding naked exposures in the F&O segment and if any of them gets embarrassed on the short side, there will be frantic covering. The domestic mutuals are net buyers as well at the moment. So the short side could be hit by a double-whammy.

This likelihood of short covering leads us to expect another big plus session sometime next week. But selling will also start coming in above current levels. It would take extraordinary events for the index to break out past 4400 (upside) or below 3900 (downside). Yes, that is a big range.

Options carryover has been skewed with call open interest dropping overall (though it increased in the Sept-October series). Open puts increased across the board. There has been a little rise in the put-call ratio in terms of open interest but at 1.17 it’s still in neutral territory or only mildly bullish.

If we examine August bull spreads, a long 4200c (51.5) versus short 4300c (17.9) offers a cost of 34 versus a maximum payout of 66. In the September segment, a long 4200c (132) versus short 4300c (88) costs 44 and pays a maximum of 56.

An August bear spread with long 4100p (36.4) versus short 4000p (17) is much more attractive in terms of risk:reward with a cost of 19 and potential payoff of 81. Considering the expiry factor, a September long 4100p (132) versus short 4000p (96) costs 36 and offers a maximum payoff of 64. Even in September the close-to-money bear spread is more attractive.

As mentioned earlier, there is a good chance that the Nifty will touch both 4000 and 4300 levels within the settlement since it has been swinging through about 150 points on daily basis.

A covered straddle combining the September long 4100p and the September long 4200c would cost about 80 and hit breakeven if the market moved outside 4020-4280. Again, this is not far-fetched but the payoff will be small unless you can hold till well into the September settlement.


STOCK FUTURES/OPTIONS

In the stock market, the narrow focus trading makes it difficult to recommend many positions. There is, rather surprisingly, a lack of arbitrage situations.

Of the most active stock futures, Century Textiles is the only surprise counter, generating big volumes. The other potential dark horse seems to be Omaxe, where trading is looking up.

In these and other counters, one would prefer to pick up the September futures if at all, because of the expiry factor. That is despite the fact that Century has started generating very heavy volumes and open interest in the August futures quite late into the settlement.

Among other stocks, very few appear to have a genuine trend – most are range-trading. There could be some investment buying in banks though the trend is mixed there and GMR Infrastructure is likely to attract short-covering.

Apart from that, there is determined support for several Reliance and ADA group companies.

There has been a mild pick-up in metals (both ferrous and non-ferrous) and shares such as Tata Steel, Sail, Hindalco and Sterlite could benefit if this turns into a genuine trend.

Stocks such as ACC, Bhel, M&M, L&T, Satyam, Tata Motors are seeing buying at lower levels but all of these would be dangerous to trade prior to settlement.