Bear spread attractive

A bear spread as well as a strangle have better potential compared with a bull spread.

The settlement went through with record carryover and the mood was buoyant.

The introduction of two new index derivative contracts on the Nifty Junior and CNX 100 could further energise the market. FIIs and mutual funds were net buyers and the FIIs certainly increased their futures and options commitments.

Index strategies
The Nifty closed at 4297 in spot after hitting intra-day highs of around 4325. The June contract was settled at 4285 while the July contract was last held at 4280. Open interest surged in both contracts to record levels for this stage of the new settlement.

Of the other indices, the Bank Nifty was at 6405 in spot and at 6383 in the June settlement while the CNX IT was at 5270 in spot and at 5289 in the June contract. Both have ample open interest in the June contract and zero open interest in the July contract.

The newly-launched Nifty Junior and CNX 100 futures are likely to attract interest because the constituents of the underlyings are all heavily traded. There are some interesting cross-hedging possibilities.

The CNX 100 incorporates the Nifty and Nifty Junior universes. Once liquidity develops, it may be possible to create many market-neutral strategies. This is also likely to lead to expanded interest in the Nifty Junior universe.

The premium-differential patterns of the Nifty future and spot suggests that the market expects further uprend.

In this case, the June contract could increase premium versus July and close in on the spot. A long June- short July calendar spread would work.

The Bank Nifty position is interesting. The spot has developed premium with respect to the future, which is unusual. It's usually the other way round in a bullish scenario.

It would seem to indicate bearish expectations, which contradicts other technical signals, which are generally positive. It's a puzzling signal but on the whole, I would tend to disregard this and go with the positive verdict. It's early in the settlement and an imperfection in the F&O signal is therefore, more likely.

There are several factors in favour of a continued bank rally. The Carlyle 5.6 per cent buy into HDFC is expected to lead to cash flowing into HDFC Bank as HDFC attempts to shore up its own holding. This may already be happening. The ICICI follow-up issue is likely to keep the pot boiling and SBI is also bullish.

In addition, money market liquidity has improved and the effect has already been felt in sharp drops in the call money rate. The CNX IT futures' premium versus spot is a normal situation.

However, the negative performance of the index this week conceals underlying strength. Of the constituents, a majority gained on Friday but the heavyweights were lacklustre. If the rupee weakens slightly, the CNX IT could be all set for a surge.

In the Nifty options market, the settlement carryover pattern has led to a perceptible increase in the put-call ratio which has gone to 1.6. That's bullish by definition but again it's rather early in the settlement to read too much into this signal.

For what it's worth, the put-call ratio pattern appears to be classically hedge-driven; a lot of people with long positions across the market have also bought puts.

Our perspective on the Nifty is that it's most likely to trade between 4225-4325 in the short run and to move up to around 4425 sometime inside this settlement. If there's a downturn, the correction is likely to find support by 4125.

Hence, a short-term trader with a four-five session perspective should concentrate on 4225-4325, which implies a mildly bearish outlook. A position trader who is prepared to hold for a longer period can consider 4125-4425 as the range.

Pricing is asymmetrical with close-to-money puts being rather more expensive than close-to-money calls. A bull spread with long 4300c (93.75) versus 4350c (69.85) costs about 24 and pays a maximum of 24. A wider spread with long 4300c and short 4390c (48.95) costs 45 and pays a maximum 45. These are acceptable but unexciting risk-reward ratios.

A bear spread of long 4300p (111.8) versus short 4250p (90.4) costs 22 and pays a maximum of 28. A wider bear spread of long 4300p versus short 4200p (72.25) costs 40 and pays a maximum of 60.

These ratios are significantly better than the comparable bull spreads. However, a long 4250p versus short 4200p offers even better risk:payoff ratios since it would cost about 19 and pay a maximum of 31.

Strangles are interesting. A long 4250p and long 4350c costs a collective 160 "� this would require a move outside 4090-4510 to breakeven. It may be worth selling with a 5-session perspective. If it's covered by a long 4150p (56) the net premium inflow comes down to 114. But the downside is completely covered and assuming that there isn't a huge upwards breakout, it should be possible to close out the calls with a profit.

STOCK FUTURES/ OPTIONS

There are a few small arbitrages available in the stock futures segment. These will be played out very quickly on Monday given the number of institutions attempting to exploit these differences. However their actions will have a market effect and it may be possible to piggyback.

For example, the Reliance Industries June future was settled at 1761 and it closed at 1751. Not much, but it will cause selling in futures and buying in spot.

Tata Steel June was settled at 629.75 while the spot closed at 635. This will lead to buying in futures and selling in spot. MTNL is a possible "dark horse" "� the spot closed at 163 and there's lots of open interest in the 160c (9.6).