InvestorQ : What F&O trends you suggest that I must closely look at while taking a view on the markets?
Neelam Naik made post

What F&O trends you suggest that I must closely look at while taking a view on the markets?

Priyanka N answered.
3 years ago

It sounds a little esoteric but if you try to understand the basic rules of identifying trends through futures and options, you can have your own small success in trading the market. Here we cover some basic methods that traders and investors can use profitably by looking at some basic F&O data trends. It just calls for a little bit of effort on your part. Here are some classical F&O trends to look at.

Start your F&O data journey with the VIX

The Volatility Index (VIX) is now a traded product on the NSE. Originally, designed by the Chicago Board of Exchange (CBOE), this is a measure of volatility that is implicit in the market. This is a very important measure of the market as it gives a quick view of the quantum of fear in the market. Hence it is also popularly known as the Fear Index. There are no hard and fast rules for the level of VIX but a level of 18-22 is considered to be the normal range for the VIX. This data is available on a real time basis in the NSE website. Once the VIX crosses 22, you need to focuses on how rapidly it rises from these levels. A rapid raise from the 22 level is a signal of an imminent fall in markets.

You can position yourself accordingly by buying put options or selling futures. Secondly, VIX is also a signal of markets bottoming out. Normally, markets never bottom out when the VIX is high. When the VIX falls sharply below the 18 mark and begins to consolidate, you can take this as a signal of a market bottoming out. That is when you must start buying the stocks that you want to add in your portfolio.

What does the accumulation in OTM calls and OTM puts tell you?

It is an indication that institutions are active in these OTM puts and calls as only then you find a sharp accumulation in open interest. Secondly, it also shows that there are expectations of a sharp movement in the market. Take the case of the recent fall in January/February and the sharp rise post the budget. From the beginning of January, there has been consistent accumulation in OTM puts, clearly indicated by the open interest. Not surprisingly, the markets corrected almost 10% from those levels. On the other hand, just after the Union Budget announcement on Feb 29, one could see aggressive accumulation of 7200 and 7300 strike call options on the Nifty. The Nifty subsequently rose sharply by about 700 points. Such data is available on a real time basis and you can get an idea of the accumulation when you compare it with the previous day’s data.

Do you see spread strategies happening in the markets?

This is a slightly more tricky technique of identifying trends in the F&O market. Typically, institutions and traders, at times, do not want to bet on the direction of any sector. Then they resort to spreads. In a spread, you bet that one sector will outperform the other sector. Take the case of banking sector currently. There is a strong expectation that the RBI will cut rates by 25 basis points when it meets.

However, being an uncertain variable nobody wants to take a directional bet on the same. Hence if you look at the accumulation data there is a clear accumulation of long positions in the Bank Nifty and short positions in the Nifty. This strategy is profitable if the Bank Nifty performs better than the Nifty. For example if Nifty gives 5% return and Bank Nifty gives 7% return, you still end up making a 2% profit. On the other hand, if Bank Nifty is down 4% and Nifty is down 7%, and then you still make a profit of 3%.

Look at futures premiums and discount

This is far simpler to understand and traders use this to decide whether to buy in cash market or in futures market. Normally, futures quote at a premium to the cash market as there is an interest cost to funds. The spread may be in the range of 0.7% to 1.2% per month depending on the volatility of the stock. A high premium is normally a sign of bullishness and one can look to accumulate in the cash market. What about discount on futures?

The most common reason for discount on futures is the declaration of dividends as dividends accrue to the cash market buyer and not to the futures buyer. But there are other occasions when the futures quotes at a discount without dividends. This could be a signal of cash market selling by institutions and should be construed as a negative signal on the stock. You need to position yourself by selling futures or buying put options.

Of course, you must look at the fundamentals of the company and talk to your advisor before taking an investment decision. But, the beauty of these techniques is that they are simple, workable and the data is available in the public domain. You can at least use it to ratify your investment decisions.