Bear-spread better than bull-spread

Risk-reward ratios in bear-spreads have been good for nimble traders.

The market heads into settlement week apparently still in a strong uptrend. However there are signs of greater volatility and randomised stock-specific movements, which could make for unpredictable intra-day swings in the Nifty. There is already plenty of volume in the December F&O series.

Index strategies: the spot Nifty closed on Friday at 3951 while the November Nifty was settled at 3953.7 and the December Nifty at 3961.5. There is also acceptable open interest in the January Nifty, which was settled at 3965. As of Thursday, the spot and November must align and if the trend holds, there will be plenty of rollover volume moving to the December series.

The most likely outcome is that December will gain relative to the other series. One idea is a bear-spread, where you short November and buy December.

This will gain if the differential between the two series increases""that is, if December moves to a bigger premium. Another possibility is long December, short January""which gains if the January premium over December disappears.

The Bank Nifty has eased off somewhat and gained only nominally this week. Spot Bank Nifty is at 6153. November Bank Nifty was settled at 6164 while the December Bank Nifty was settled at 6180. By historic standards, the differential isn't much.

Again, a bearspread may work, with a short November, long December""if the differential increases to normal levels""which is usually over 25 points.

The CNX IT shot up nearly 5 per cent this week. The spot CNX IT closed at 5244 and the November series was settled at 5235. The December series was last quoted at 5250 but this is academic since there is no open interest in the series.

The differential between November futures and spot is likely to correct on Monday itself with the technical position that a lot of money will go long. However, this is a naked position so it would be high-margin.

In the Nifty options market, the put-call ratio has eased to 1.3, which is still high but lower than in previous weeks. Prima facie, this indicates that the market is more likely to go up rather than down.

Obviously November positions must take the expiry factor into account. While December Nifty options have quite a lot of liquidity, premiums are high and one would rather not suggest positions here until Thursday.

Technically the market is likely to stay above support at Nifty 3800 and to yield net gains""we are likely to see 4000-plus next week. But that gives both bulls and bears some trading options. Even an intra-day dip till 3800 would offer handsome returns for a bear spread.

A standard bullspread with long 3950c (32.85) and short 4000c (10.65) costs 22 and pays a maximum of 28. A standard bearspread of long 3950p (29.55) and short 3900p (14.2) costs about 16 and pays a maximum of 34. I've been advocating holding bearspreads through the previous few weeks despite the rising market. This is because the risk: reward ratios have been much better than with bullspreads in the rising market.

Those bearspreads have actually paid off for nimble traders during the occasional sharp intra-day correction such as occurred last week. Once again, I'd say that the bearspread makes more sense than the bullspread. There are a couple of other suggestions worth thinking about.

One is a long 4000c""the premium is under-priced. The uncovered 4000c costs about 11, which will pay off if the market moves beyond 4012 within the next four sessions.

There's an excellent chance of that occurring and the uncovered position actually costs less than closer-to-money bullspreads. In practice, if the market moves up even a little, the call premium would jump.

The other possibility is to try and sell deep puts or calls. On the upside, there isn't much liquidity, so selling calls isn't really possible.

If you find counter-parties, a reversed bullspread with long 3800p (4.15) and short 3750p (3.5) fetches a little cash though this has a very adverse risk:reward ratio. You stand to lose a huge amount if the market does tank.

STOCK FUTURES/ OPTIONS

In the stock derivatives market, the expiry factor is crucial. There are three or four positions that could work even inside four sessions because the technical positions are clearly trending.

On the long side, there's volume in IVRCL, NTPC and Zee. The November IVRCL Infrastructures future settled at about 421 while the last closing spot was 424. This could be a long position. We see a target of 460-plus for the underlying.

In Zee Telefilms, the future was settled at 369, which is pretty close to the last spot price. However there is a fair chance that the Zee stock could rise till at least 385 and maybe 400-plus.

NTPC jumped past 150 and looks quite strong as well with a technical target of about 170. An uncovered long 150c (3.3) looks quite reasonable. It is possible to create a bullspread as well with a short155c (1.7).

The bullspread would cost about 1.6 and pay a maximum of 3.4. Given our optimism about the stock's strength, it may make sense to let it run naked despite the expiry situation. At worst, you lose 2 per cent of the spot price and at best, you could make a return of several multiples.

On the short side, Siemens is seeing a lot of selling. The future was settled at 1184 while the spot is at 1177. You may arbitrage by buying spot and selling future for a very small return. Or you could short the future.