Bear-spread still makes sense

A bull-spread would only start paying off if there's a move past 3880.

The market continued to rise but in a more uneven fashion than hitherto. There were clear differences in speculators' attitudes to different sectors. Open interest continued to zoom across the board with two week still to go before the settlement.

Index strategies
The Nifty touched 3900 levels before easing down to close at 3852 in the spot market. The November Nifty futures continued to trade at a premium, closing at 3857 on Friday.

The December futures were held at 3856.95, which is a marginal discount to the November series. We still don't see an arbitrage opportunity here. As far as one can tell, a premium on the future is indicative of bullishness, and expectations would still be inclined that way.

The Bank Nifty shot up by an amazing 6-plus per cent to close at 6119 in the spot market. It was held at 6111 in the November futures market.

This is interesting"�the Bank Nifty near-term future has usually traded at some premium to the spot but the spot market was very strong towards the end of Friday's session.

Since several individual bank shares continue to seem bullish, a long Bank Nifty position is reasonable.

The December series is trading at 6174 but unfortunately, there is little liquidity in the contract. If you can find counter-parties, try to take a calendar spread of long November Bank Nifty and short December Bank Nifty. The 60 point difference should narrow.

The CNX IT has also been bullish in the past few weeks and tended to outperform the Nifty. There is zero liquidity in the December contract so there is no chance of taking spreads here. The spot is trading at 5003, while the November future was settled at 5002.5 on Friday.

Importantly, the rupee weakened last week versus the dollar. If this trend continues, it's positive for the CNX IT so the sector may continue to move up. But unlike the Bank Nifty, these would be unhedged, high-margin positions.

In the options market, the Nifty put-call ratio continues to rule above the 1.4 level in terms of open interest, which is clearly indicative of expectations of continued rise.

However quite a lot of puts were cashed out on Friday and the PCR has come down. Whether a relatively lower PCR will translate into a fall in actual market prices is a different matter.

Anyway, in terms of option spreads, a long 3850c (58.1) versus a short 3900c (34.75) costs 23-24 and pays a maximum of 26-27.

For the first time in this settlement, we're getting a reasonable risk:return ratio for a bullspread close to the money. If we look at a slightly more optimistic long 3900c (34.75) versus short 3950c (17.95) the cost is about 17 and the maximum payout is about 33. That's a fairly decent risk:reward ratio.

In terms of bearspreads, a long 3850p (50.75) versus a short 3800p (34.05) costs about 16 and pays a maximum of 34. A wider bearspread with long 3800p versus short 3750p (23.2) costs about 11 and pays a maximum of 39.

I've been consistently advising bearspreads despite the rising market on the basis that the risk:return ratios are better.

At the risk of becoming a bore on the subject, I would say the bearspreads still make more sense. A bearspread would be profitable if there's a minor twitch till the 3830 level whereas a bullspread would only start paying off if there's a move past 3880.

There is sufficient liquidity now for us to contemplate a set of strangles or straddles. A set of long 3850 put and call (58.1+50.75) would be profitable if the market moved beyond 3740-3960. If it's laid of with a short 3950c (18) and a short 3750p (23), the cost drops to about 69.

Hence the position is profitable between 3780-3920. The risk:reward ratios still don't work so, we could look at the reverse position with a short straddle at 3850 coupled to long positions at 3750p and 3950c. This position is profitable if the market stays inside 3780-3920.

We can also try a long strangle with long 3800p (34.05) and long 3900c (34.75) "� this costs 69. If it's laid off with a short 3950c and a short 3750p, the cost drops to about 28. That position is profitable outside 3770-3930 and the maximum payoff is about 22 for a cost of about 28. Still not terribly attractive.

STOCK FUTURES/ OPTIONS

The stock derivatives section isn't looking quite as interesting as it was a week or two ago. There is one potential arbitrage position assuming you hold delivery in ICICI Bank.

The November ICICI future is trading at about 873 while the spot is at 882. You can buy the future and sell the spot, intending to reverse and lock the differential.

Apart from this, there is a fair amount of long pressure building up in SBI and in ACC. Both stocks are worth long futures positions and SBI may also be worth a bullspread at long 1230c (30) versus short 1260c (18.8). This costs about 11 and pays a maximum of 19 so the risk:return ratio is quite decent.

Another interesting position is available in NTPC. A long 140c (3.4) versus short 150c (1) costs about 2.40 and it pays a maximum of 7.6. That's an excellent risk:return ratio and the stock does seem bullish. On balance, this is perhaps the best stock bullspread that we can unearth at the moment.