29 August 2010

Volatility Bottom ?

Observations :

Volatility is very near to its historic lows. 
Nifty struggling to take out resistances at higher level.
Nifty very near to channel top.

Expectations :

Volatility to rise.
Chances of a correction much higher than a breakout rally. (4:1 if my conviction matters)

Opinions :

Current low volatility, means low option prices.
Best way to position oneself - buy naked puts.
Hedged play : buy 5400 put and sell 5300 or / and 5200 put. (buying selling leg can be tried to time)

Risks :

We are looking at a long term chart here, so doesn't mean we are going to see a rise in volatility, immediately. So expiry of the options should be chosen keeping that in mind. Though I would go for September expiry, October would be ideal !

20 August 2010

Nifty : Decoupling Again?

For last few weeks we have been seeing extreme resilience in the Indian stock market when compared to western indices. Nifty has been outperforming even its front-line Asian peers like Japan, China and Hong Kong. Only Thailand, Indonesia and to some extent Singapore apart from India are avoiding the Global weakness. This has led to a lot of decoupling talks specially among the Asia specialists.

But you don't need to look far behind to see what happened to them last time around in late 2007; when this new concept was peaking and making headlines, we saw Indian as well as other major Asian markets showing strength, collapse.

No one knows whether we can ever decouple, but slowly and surely this is happening. The economy is far likely to decouple than stock market which has become one big global playground. Institutions in the hunt of return put money even in the weaker markets, hoping that excess liquidity will finally push the valuations. I have no doubt in Indian growth story but it is too early to think that we can have a bull market while others fear about economy.

We can easily see that the latest leg of rally has totally been fueled by FIIs which I guess is due to a substantial re-allocation of funds. If the fear of double dip, deflation etc recedes I am sure there will be lot of money moving back to those markets which have fallen. And if we really get into trouble, God save our stock market. So either case I don't feel we can expect much return from the markets from here on, though we can keep drifting higher as liquidity is ample. But remember liquidity is never there when it is most required, recall early 2009.

Above is the chart of ratio between Nifty and S&P 500. Note that its at an all time high, higher than it was during 2008 bull run. We can expect mean reversion possible very soon, which if happens would be smaller market following the larger one, rather than the opposite. I would expect a reversion to 50day moving average  on the cards pretty soon, which at current level of S&P 500 would mean (4.65*1070) is very close to 5000!
If the SPX falls more the lower the target!

08 August 2010

Market Breadth Indicator

After a 23rd July peak, Nifty has been dipping shallow and then reaching those heights again, but in a very tentative manner. Last week we saw levels from 5400 to 5475, of a meager 75 points, with entire trading concentrated in the region of  5420 - 5460 even more tight range of 40 points. So while we wait for breakout in either direction lets take a look under the hood.

Above is the chart which shows what was "most probably" happening in the stocks belonging to the F&O segment in the August series. I have chosen this as compared to entire set of NSE stocks because most of them belonging to the small cap universe tends to skew the count as well as percentage of stocks calculation. F&O segment is where the real game is played. Alternately we can use the valuation method but that can complicate things more.

So coming to the chart, I have marked the 4 regions in the chart which is based on percentage of stocks in F&O segment showing the 4 possible trading. Lowest region shows Long Unwinding, above that in a lighter reddish hue is Short Addition, the greenish hue above it marks Short Covering and the top most lighter greenish area shows Long Addition. The X-Axis as usual is the time frame.

I have also added Nifty chart right below it to make comparison easier. We see till 23rd June, 5350 in Nifty short covering was a dominant trade going on, which tell us a well known obvious fact that all rallies start with short covering. Notice how smart longs were getting into the party. We also see some short getting added!

After a period of lull, where we see short and long all getting added Nifty reaches the 5470 high on July 23rd, with quite a significant number of stocks adding long only the previous day (signs of excessive bullishness?). We also see that shorts were getting added in large number of stocks closer to that period, I feel the reason to it would be as Nifty was nearing a resistance level so were a lot of other stocks and hence these build up.

Now see what has happened after that, Nifty is where it is, but we are seeing Long Unwinding, which we have almost seen happen in august series! There is hardly any long position getting added, short covering has also increased which almost ceased during the 23rd July top!

You can, I am sure make more interpretations from this chart. But one thing that is on your face here is that there are lot of long as well as short positions, some of which have been flushed out of the system recently. If market breaks on the downside the longs (covering) will surely make things worse. If there is a breakout there are enough shorts build up in the system to spring Nifty to greater heights. We can see a burst of short covering yet again.

As this chart is based only on percentage of stocks exhibiting the trading biases, its only a breadth indicator and not a strength indicator.