Bear spread may work

DERIVATIVES

A standard bear spread offers a fairly decent risk:return ratio.

The massive sell-off last week could continue through at least part of this week. There is a fair chance that it may turn into an intermediate downtrend that continues through several weeks actually.

On the other hand, a technical bounce is also quite likely. We have plenty of time to go before the settlement and there are any possible trades in both the index and stock F&O sections.

Index strategies
The spot Nifty is at 3345 with the April Nifty future trading at 3348 with over 2.6 crore open interest (OI), May Nifty future at 3343 with 11 lakh OI and June Nifty at 3341 with 75,000 OI.

There is plenty of liquidity and OI increased in the May and June segments although it fell in the April futures. The futures are running at marginal discount to each other but this is hardly worth the arbitrage.

We could employ a calendar bear spread by going short April and long May in the expectation that the differential between these two series will become even less. We could also take a simple naked short April position in the expectation of a further drop in the market.

Our technical perspective is that 3290 is bound to be tested again inside the settlement and if 3290 is broken, the Nifty could fall till 3250 levels very easily.

On the upside, the Nifty will start running into resistance around 3380-3400. Expect very high intra-day volatility as we have experienced in the recent past. Daily movements with a high-low range of 2.5-3 per cent of the closing price may be the norm.

In the index options segment, a lot of puts (over 6 lakh) have been settled in the last session while a lot of new calls have been opened (more than 8 lakh).

The put-call ratio has dropped to nearly one. In the context of the last year's trading, this PCR is close to being overbought! We are unlikely to see a technical bounce purely on the basis of this ratio.

A standard bull spread close to money such as long 3350c (58) versus short 3400c (39.8) costs about 18 and pays a maximum of 32. This is a pretty good risk:return ratio and tempting even though our expectations are bearish and this position is unlikely to be fully realised even on a technical bounce.

A standard bear spread close to money such as a long 3350p (62.15) versus short 3300p (40.5) costs about 22 and pays a maximum of 28. This is a fairly decent risk:return ratio and we could expect this position to be hit and fully realised.

A wide strangle such as a long 3400c (40) and a long 3300p (40) costs around 80 and pays off if the market moves beyond 3220-3480. An even wider straddle such as long 3250p (26.65) and long 3450c (23.5) costs about 50 and pays if the market moves beyond 3200-3500.

By our reckoning, either could be hit but the payoffs are likely to be small. At the same time, this market is too volatile for us to confidently create short straddles.

Let us take a look at the other two tradeable indices. The Bank Nifty is at 4467 dropping an incredible 8.3 per cent in three sessions. The April future is at 4505 while May is at 4520 but with very little liquidity.

A short on the April future seems a fairly good position "� the index has room to drop till 4400 and the future is running at a substantial premium. You could hedge this with a portfolio of long positions in SBI, ICICI and HDFC Bank.

The spot CNX IT is at 4140 with the April future at 4161 and the May future at 4207 with low liquidity. The premium on the future is less marked than with the Bank Nifty but it is still appreciable. Again, a short position can be created and this could perhaps be hedged with long positions in high-weight IT shares such as Infosys, Satyam, TCS and Wipro.

STOCK FUTURES/OPTIONS

In the stock list, you will have to stick to futures in most instances. There isn't enough liquidity in the options section.

There are three sets of trading possibilities in the stock F&O list. One is of potential defensive stocks where long positions can be taken. Here the best possibilities seem to be ACC, Dabur, Maruti and Reliance.

These stocks held their ground through the bloodbath. Long futures positions in these could work through next week even if the indices go into a further decline.

Metal shares such as Sterlite, Tata Steel and Hindalco did reasonably well and so did NTPC. However, metals have run up a bit too fast and may be topping out. NTPC doesn't look as though it could move against the market if there's a further sharp fall. So it is best to ignore these.

The second set of stocks involves those, which lost a lot of ground and continue to look weak. This includes Bajaj Auto, Bharti, BHEL, Cipla, Corporation Bank, Grasim, HCL Tech, HDFC, HDFC Bank, Hero Honda, ICICI, IPCL, Infosys, ITC, Larsen, Mahindra, SBI and TCS. All these seem to be fairly clear targets for shorting in the futures segment. Our best picks would Hero Honda and Cipla.

The third set consists of shares, which could move both ways. The most interesting here seems to be Satyam where spot is at 772 and the stock could move anywhere between 740-800. A bull spread with long 780c (34.3) and short 800c (25.7) costs about 8.5 and pays a maximum of 11.5.

A bear spread with long 760p (24) and short 740p (13.5) costs about 11 and pays 9. Our suggestion would be to take a short April Satyam future (776) and combine that with a bull spread.