Risk aversion paves way for risk premium

Written by arup misra | Updated: Aug 31 2009, 06:46am hrs
Economic news emerging from across the developed worlds continued to be largely positive. This helped check any weakness due to profit taking. While the US and European market remained flat, the Asian markets were lower due to volatility in the Chinese markets. On the domestic front, while the government has indicated that the monsoon situation is worrisome, but there are adequate food stocks to care of any exigencies.

Indian markets remained buoyant for most of the settlement week with small bouts of profit taking. The mid and small cap stocks fared better than their large counterparts as indicative of the positive market breadth for better part of the trading week. As a matter of fact A/D (advance decline) ratio has been on the increase since the start of the uptrend in Mar 2009. This if seen in conjunction with heightened participation across both cash and derivatives segment comes across as a dj vu.

A step back in history to 2003 is where we find similar behavioral pattern. Back in 2003, the economy was coming out of a growth slowdown led by both global and local factors (drought). Valuations were at their lows, traded volumes struggled, declines far outnumbered the advances but the markets started to rally hard on the back of liquidity and sustained the performance beyond 2004 as well.

Coming back to 2009, in March valuations too were at rock bottom, volumes were scanty but then economy was sloshing with liquidity owing to the liberal doses of fiscal stimulus doled out.

The moot question is would we see a repeat of the Bull Run which lasted from 2004 to early 2008 If data from derivative is anything to go by, this certainly is a possibility. Nifty call options of 5,000 and above strikes beyond December 2009 have an open interest of 11.36 million shares representing nearly 27% of the total open interest. Although volumes remain scanty on long dated options, their premiums have been on an increasing trend. This suggests that participants are betting on higher levels hence willing to pay more premiums.

The August F&O expiry has thrown in a couple of insights as well. Nifty saw a rollover of 75.41% vs. 68% for the same period last series and 61.7%being the last three month average. In absolute numbers, 23.29 million shares got rolled over in line with 23.08 million shares in the last series. Market wide roll over was 81.28% higher than the last series and better than the last three month average of 69.06. These are again signs that participation is increasing and the risk aversion has given way to risk premium.

I reckon that momentum will continue to stay positive (the lack of rainfall will have a lesser-than-expected impact on the industrial economy), liquidity will continue to be strong and with indicators as mentioned above, the market is likely to make positive progress in the months ahead.

Key catalysts could be reforms and infrastructure spending, although heightened volatility could make trading a less-rewarding strategy. They key to reaping a rich harvest would be a right mixture of stock-picking, accumulating at every fall and patience.

Safe Harbor Statement: Nothing in this article is, or should be construed as, investment advice.

The writer is a derivatives analyst