An Auspicious August for Nifty?

TRUCE BE TOLD:

History is replete with many a truce, where two warring forces take a small break in the middle of a war, before resuming their hostilities. The most remarkable of these was the ’Christmas Truce’ between German and British troops during the Christmas of 1914, amidst the madness of World War I. For, not only did soldiers, who had been firing at each other relentlessly for weeks, come out of their trenches and share pleasantries and gifts, but they also had a party — sharing cigars and whisky. Ironically, the same soldiers got back to business the very next day and started gunning each other to death — because a truce was, after all, just a truce!

THE SETTLEMENT TRUCE:

In a similar vein, Nifty bulls and bears seemed to have called a truce last Thursday — the settlement day of the July series of derivatives contracts. For, not only did a series that gyrated all through its existence like a drunken reveller, end absolutely flat, but it also ended with one of the lowest rollovers in recent times. To top it all, the settlement day saw a boring session, with the typical expiry fireworks missing. Not that there was no reason for a massive bull assault. The previous day had seen massive buying in the 4300 call and an in-the-money put like the 4400 put had seen healthy build-up, ending the day even below its intrinsic value (the difference between the strike price and the price of the underlying).

Generally, a put option trading below its intrinsic value, particularly if it’s building up open interest while doing that, is seen as a very bullish sign. It suggests that stronger hands are writing these puts, knowing very well that their cash buying will push the underlying above the strike price, rendering them worthless. And so, even if they sell these puts dirt cheap, it’s a profitable trade. Even rollovers, at about 53.75%, were much lower than the last six month’s average of 61.72% on the day before settlement (S-1) day. So, there was enough ammunition (read short positions) for a sharp rise, which would have butchered many of these shorts.

However, that didn’t materialise and the Nifty ended almost flat on settlement day. It was quite like the 15th round of a heavyweight-boxing bout, where both the boxers have run out of gas and are just waiting for the bell. The fact that it was just a truce became amply clear by the bull assault that followed on Friday. That a large number of bears bailed out during the truce, is clearly reflected in July rollovers, which at 65.05%, were substantially lower than the last six months average of 70.13%.

THE FRIDAY PARTY:

Although Friday’s 80-point Nifty rally may not seem like much at first glance, in many ways, it’s the first real confident move by bulls in a very long time. While Nifty August futures added close to a whopping 20 lakh shares in open interest, the premium on them shot up to 19.3 points from just 2.15 points on Thursday — a clear reflection that most of the fresh build-up on Friday comprised long positions. If we add the fact that a majority of short positions have not got rolled over into August, we can conclude that the market is now net long in the Nifty.

The picture is even rosier for bulls when it comes to single stock futures, which added a whopping 8.8 crore shares in open interest on Friday — the highest single-day addition of open interest in recent memory. With it, stock futures have now cumulatively added close to a whopping 15 crore shares in open interest in the last three trading sessions. And given that the last three sessions have ended with handsome gains, a majority of these have got to be long positions.

The icing on the cake was that it came on a day when global cues were bad and the Nifty had opened with a massive gap down. The only cause for concern is that a majority of this buildup occurred in the momentum counters, though there’s hardly any momentum left in them.

FRESH TRADE:

Last week, we had suggested avoiding the July series, expecting high volatility, and had recommended going long in August futures on Wednesday. Both these calls were vindicated as volatility rose to never-before seen levels — the India VIX (volatility index of Nifty option contracts) closed at an all-time high last Tuesday. As for the long Nifty futures, anyone who would have gone long early on Wednesday is now sitting pretty with gains of 150-200 Nifty points. And since Friday saw the re-conquer of the 50-day moving average (DMA), one should ideally sit tight and just ride this tide, with a strict stop-loss at a close below the 50 DMA, which is currently at 4347.55. The next possible target for this journey should be the last top made at around 4540 on July 24, ’08.

What about a fresh entry? For those of you who have missed this bus, it makes sense to abstain from entering now, as most casualties take place when people try to board a moving bus. So, wait for the Nifty to take out this last top at 4540 and then wait for a pullback to go long. For, with a hit (preferably a close) above 4540, the Nifty would have made a higher top for the first time since May. With a higher bottom already in place, this will put the Nifty back on a bull market pattern of higher tops and higher bottoms. As for the bears among you, extend your holiday because life for you begins only below 4159 (the panic bottom created by RBI’s rate hike last Tuesday). That may also coincide with the 20 DMA, which currently is at 4317.6, and will mean that this bear market rally is over.