An inside bar sets up Nifty to open the next week on a positive note aiming 22841-22954. Should rejection trades set in, 22700, or 22550 may be used as stops on the way down. Collapse theories may have to wait for a break of 22300 to get activated. While Nifty straddles are pricing in about a 500 point range on either side, giving us just a 23000-22000 band, VIX which has been steadily playing near 24 last week, is pointing towards the potential for a 7.1% rise or fall this month, which pips the upper range at 24100 and lower range at 20930. Meanwhile, we saw FIIs adding on to short positions in index futures, which now constitutes 87% of the total FII positions in index futures. FIIs started the new series on 31st May having reduced the longs in index futures to just about 20% of what they held on the expiry eve, while shorts were increased by 32%. This is a heavy bearish bet, but if it goes wrong, it can also give legs to massive rallies. But, historically, there is enough evidence to show that any build up in prices in anticipation of an event, fizzles out almost immediately on maturity of the event. Hence, while 24k mount is a theoretical possibility, we feel that the probability of attaining it is low.
Iron Butterfly option strategy
The build up to the election results has inflated the 6th June contract’s option premia multi fold, and given the fact that a fall in VIX post event is usually seen, a directional bet is fraught with high risk. Towards this end, our preference is to employ an Iron Butterfly option strategy to benefit from swollen premia ahead of exit polls and the expected fall in VIX as well as premia once the event has transpired, as evidenced in 2019 as well as 2014. At the centre of the Iron Butterfly is a short straddle with a short PE and short CE as the two legs which stands to benefit from fall in premia, if history repeats with VIX. The other two legs are a long PE and a long CE on either sides, which serves as a hedge to the straddle, should there be wild swings.
Sector in focus
We have looked beyond the sectors that are pipped to respond positively to continuation of the regime at the centre and prefer to look at IT index which lost around 4% last week led by selling pressure seen in TCS, Wipro, TechM and Infy. The fall accelerated taking cues from US IT stocks like Salesforce, Microsoft, Alphabet and Amazon after US economic growth came in at 1.3% lower than previous 1.6%. Around 90% of the Nifty IT stocks are nearing oversold region but only 45% of the stocks are trading above 20DMA which hinting at the fact that a strong reversal is still far away. We could see some relief in the next few days but as MACD in the daily timeframe has breached the signal line, we should be expecting such pullbacks to be sold into. In the case of Nifty IT index, once 32400 on the downside is crossed on a closing basis, we should expect 31000 before forming a base. The best strategy to deploy would be to add heavyweights, especially TCS, in a staggered manner.
First published in Financial Express
