Bear-spread makes sense

DERIVATIVES

As has been the norm through this bull run, the risk:reward ratio is much more favourable for the close-to-money bearspreads.

Settlement went off smoothly enough with prices stable despite a lack of volumes in both the F&O and spot segments of the market. Institutionals remained net buyers however. We will have to assume that 2007 will see a massive volume expansion as the institutional managers come back from their holidays.

Index strategies
Despite the overall lack of volumes, the trend was positive and open interest increased in a fairly satisfactory fashion in the new settlement. All three tradeable underlying indices rose strongly on the NSE and evidence of a bullish trend must have influenced a reasonable carry-over.

In the futures segment, the Nifty (spot close: 3966) was settled at 3968 in the January segment and at 3971.75 in the February segment where OI also saw a rise.

There is obviously insufficient differentialto trigger a profitable calendar trade so any positions would depend on a directional view. The small premium across the timeframe does indicate that expectations are positive.

In the BankNifty, the spot is held at 6009 while the January futures was settled at 6038. In the CNXIT, the spot was held at 5432 while the January futures was settled at 5441.

Obviously expectations have turned very positive again. The market has absorbed the implications of the RBI's CRR hike and the upwards push it gave to both the rupee and to rupee interest rates. The differentials are about par for the course.

Technically, the bank sector appears to be running into major resistances "� this will be overcome only if the institutionals remain positive in the new year and make fresh commitments. The CNX IT has a stronger technical outlook and if you wish to take a high margin naked long position, this would offer better odds.

In the options segment, the Nifty put-call ratio has risen to around 1.6. This is a bullish reading that backs the other expectation indicators. The implied volatility remains quite low "� so indeed, was the historic volatility during the settlement week.

This has its dangers "� any twitch in the market will mean that one set of option premiums will soar. In the circumstances, option writing is rather dangerous.

A standard bullspread of long 4000c (81.15) versus short 4050c (59.05) costs 22 while the maximum payoff is about 28. There is liquidity available above at 4100c (39) so, there is some room for manoeuvre.

This is a fair risk:reward ratio. A standard bearspread with long 3950p (93.15) and short 3900p (75.2) costs about 18 and pays a maximum of 32. As has been the norm through this bull run, the risk:reward ratio is much more favourable for the close-to-money bearspreads.

As things stand, both spreads are very likely to be struck within the January settlement. Under normal circumstances, volumes will expand in early January and given that the institutionals show little sign of an attitude change, bullishness is quite likely.

But one down session would send the bearspread into the black. If you have the money and you don't have a clear view, go with both spreads or go with a wide strangle, which amounts to a similar position. If you have a view, go with the bullspreads and if you want the best odds, go with the bearspread.

A wide strangle of long 4050c and long 3900p costs 135. This will payoff if the market moves beyond 3765-4185. If January is a trending month (it tends to be quite bullish) at least one of these positions will be struck. We can layoff the downside with a short 3700p (26) but its not worth laying off the upside given that the only liquid point of the call-chain is at 4100c (39) and that's too close.

STOCK FUTURES/ OPTIONS

There aren't too many plays in the F&O stock segment. Volumes are naturally low and technically speaking, most stocks are moving in line with the Nifty's trends.

In the banking sector, the best long options are SBI and ICICI and it may be about as sensible to simply go with a long Bank Nifty if you have a positive view.

In the IT sector, Mphasis, TCS and Polaris would be the picks to continue outperformance. RComm has developed some speculative volumes but the price is probably dependent on the Essar-Hutch buyout play. One cannot tell how that will go.

There has been scattered investment across ABB, Mahindra& Mahindra, Sail, VSNL and Nicholas Piramal. Hindustan Lever is experiencing selling pressure. On technical indicators the first five would be worth long positions while HLL is worth a short. Mahindra has developed sufficient F&O volumes to make it look attractive.

In the F&O segment itself, Titan and IVRCL have developed strong speculative volumes which could presage an upmove in the stock. Titan shot up sharply on Friday and saw a massive volume expansion across both cash and futures segments.

It is held at 861 in spot while the future was last settled at 867. It's early in the settlement but the arbitrage would fetch about 7 per cent annualised. A long futures position may pay more given that the trend is quite strong.

Reliance is also trading at an apparent differential with a price of 1280 in the futures segment and about 1270 in the spot. That offers an arbitrage of about 8-9 per cent net of brokerage, which is slightly more attractive. The technical position on the stock is neutral; it's likely to move with the market.