Bear spread appears lucrative

DERIVATIVES

With the results season coming up, the markets will increasingly get more stock-specific.

The settlement went through last Thursday with decent carryover volumes and a fair amount of institutional enthusiasm. The rate hike on Friday evening is likely to be unfavourably factored into this week's prices.

Nevertheless, the technical position appears to be reasonably positive and the re-introduction of stock lending could actually give the market a cushioning mechanism on the downside.

Index strategies
The spot Nifty closed at 3821 points while the April Nifty future hit 3799.85 points and May Nifty was settled at 3799.35. Open interest expanded strongly in both series. The Bank Nifty lost 3.8 per cent and closed at 5309 in the spot segment while the April series was settled at 5321.

The CNX IT eased down by 3.5 per cent and closed at 5181 in the spot segment while being settled at 5195 in the April series.

As usual, there is zero liquidity in the May series of these two indices and the CNX IT has little liquidity even in the April segment. The FIIs were net buyers last week though they sold on settlement. The mutuals remained net sellers.

Obviously calendar spreads are difficult to call in the Nifty given the near-coincidence of index values across April-May. You could take a bull spread of buy April Nifty and sell May Nifty on the assumption that the near-term will develop a premium to the mid-term series.

In the CNX IT and the Bank Nifty, the perspective must be negative due to the rate hike, which is also to cause a strengthening of an already-rising rupee. Both the futures are likely to be lucrative shorts on this ground.

In the Nifty options segment, the put-call ratio is around 0.94 at the moment. This is a low put-call ratio by the standards of Indian markets and it does indicate that the index is slightly overbought.

However, there is good support at about 3725 and our technical perspective is that the Nifty is likely to range between 3725-3925 in the next week.

This is a fairly narrow range but the likelihood of two-way movement means that narrow bull spread and bear spread could both pay off.

In terms of current premiums, a bear spread with long 3800p (105.7) versus short 3750p (87.75) costs about 18 and pays a maximum of about 32. That's a good risk-reward ratio.

A bull spread with long 3850c (83.65) and short 3900c (58.8) costs about 25 and pays a maximum of about 25. That risk-reward ratio is just about balanced. So we could say the bear spread clearly seems like a better position.

A strangle would be available at long 3750p (87.75) and long 3900c (58.8). If this is laid off with a short 3650p (54.05) and short 4000c (30), the net outflow of premia is about 60. The maximum payoff in either direction is about 40 and this would require a significant breakout from the current range. A reversal of this spread actually seems more attractive. That would mean initial inflows of about 60 and a cap on possible losses at a maximum of 40.

Of course, this is fairly early in the settlement and it isn't that wide a range so there is a significant risk. It would require intra-settlement reversals of positions "� probably in two stages.

That is, assume the market rides down and call premia drop. Reverse and exit the call positions. Then, when the market swings up again, reverse and exit the puts.

STOCK FUTURES/ OPTIONS

As the results season dawns, the market will become more stock specific. Right now, it still seems sector-oriented. As we've said above, the IT and Banking sectors both look negatively positioned in the light of the rate hike. If the RBI doesn't hike rates again in the April slack season policy announcements, it could positively surprise the markets and thus cause an upside.

Right now though, we would advise being either neutral or negative on IT and banking stocks. IFCI is moving up due to the search for a strategic partner and Kotak seems to be in a secular bull trend. But it would be dangerous to assume that these two can continue to buck a sector-wide bear pressure. Among banks, SBI could offer an arbitrage as well. The futures contract was settled at 999 while the spot closed at 994. If we assume a bearish trend, the future has a longer way to fall.

A range of pharma stocks are being heavily backed by bulls and to a lesser extent, FMCG stocks also seem to be receiving attention. These are both considered defensive sectors.

Although pharma has a lot of forex exposure it rarely seems to move in tandem with IT and the Budget was reckoned to somewhat favourable for pharma and somewhat negative for IT.

Aurobindo, Dr Reddy's and Sun Pharma would be the best picks here if you want to go long. In the FMCG space, the bulls seem focussed on ITC, HLL and Dabur. ITC looks the safest if you want a long position in FMCGs.