Technical Classroom: Detecting and trading the extremes | nifty pcr ratio - Quantsapp

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The recent turmoil in the market definitely pops a question in our minds: isn’t this enough? Today, we will discuss how we conclude on a possibility of a bottom in place (or a reversal point in place) in times like these. And, once we have a reasonable doubt, what do we do about it?

For better understanding, let us put a reference to this context and examine the recent drop that started right after the mid-term budget in 2019. The key notables that we will examine along the way are sentimental indicators like OIPCR and India VIX along with activity in the index options.

One of the sentimental indicators is being referred to is OIPCR (Open Interest Put Call Ratio). This, as the name suggests, gives us a tally of Put participants over Calls. More often than not, the recent tops and bottoms of the OIPCR shall be monitored as, around those levels, the index is also seen making at least temporary top or bottom.

Similarly, without having an event in place, India VIX is seen to exhibit a mean-reverting characteristic. Many statistical trading systems are built around this as well. We shall at least observe that India VIX is at a reasonable high or low point (six months – 1 year) and has turned around from this level.

Let us pick up all three observations and see how we are placed.

First, India VIX fell right after the event of the mid-term budget along with the market as the event was over. Despite the pullback, it kept its downward spiral. But, in the last move from 11,500 downwards, India VIX started rising and stands around the highest level since the general elections.

OIPCR also has a similar state which has been above 1 but was well placed in the range of 1.3-1.5 for most of the days after the drop started. However, after hitting a sub 1 region with Nifty around 11,300 and lower, OIPCR has now picked itself up and is now around 1.18 off its lows after index showcased choppiness in the last few days.

As far as the Option open interest is concerned, remember the struggle that Nifty had around 11,000 taking almost four months below the same to crossover. This makes it a pivotal level as signified by highly congested Put open interest.

Until now, it may not have seemed extreme, but a situation like this is a live example of creating an expectation of having an extreme situation around.

When we observe sentimental indicators at the extreme end in situations like these, the Options open interest congesting in strikes (Puts in preceding downward move and vice versa) closer to the current market level, indicative of possible extremes.

The trading strategy in such situations is very simple. Following the ongoing trend may not be profitable due to a possible turn-around. Hence, it is prudent to book out of trading strategies favouring preceding direction and be ready with low risk reversal strategies like Bull Call/ Bear Put Spreads involving higher Calls/Lower Puts.

Come to think of it, similar situations gave us some indication of an extreme around 12,000 also but was not obvious as we had an event led spike in India VIX. That is why the recent observations were referred to for the evaluation of a potential extreme.

These tactics are not exact science but have empirically been very successful in signalling turnarounds for many years in the past.

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