Bear spreads pay

If institutions continue to be massive net buyers, the market could move beyond 4600 on an intra-day basis.

There were net gains across the major indices last week although the trading pattern was choppy due to profit-booking. The derivatives market generated strong volumes and open interest expanded despite settlement considerations.

Index strategies:
The spot Nifty closed at 4566, while the July future was settled at 4544.75, the August future was settled at 4528.55 and the September future at 4517.

The Nifty Junior closed at 9034 in spot while the future was settled at 9044 and the August future at 9053.5. The spot Bank Nifty closed at 7087 while the July future was settled at 7099 and the August future was settled at 7136. The CNXIT was held at 5190 in spot and at 5161 (July).

There was a net expansion of open interest (OI) across the index futures segment "� while a lot of July contracts were closed out, even more August contracts were opened.

This is a sign that the carryover is likely to be high "� another confirmatory signal is that the FIIs expanded their overall F&O exposure.

A high carryover is generally associated with bullishness and the overall market trend suggests that. However there is a contradictory signal in the abnormally large discount on the Nifty futures that suggests traders are expecting a dip.

A calendar bear spread is marked with a short July-long August offering a 16-point difference at Friday's closing rates.

Given the number of arbitrage specialists in the market, you'll have to wake up early to get this but it will set the tone on Monday's session. The difference between spot and July future will have a less obvious influence.

Nevertheless it could mean selling pressure in the spot market. The Bank Nifty offers the reverse position where a long July-short August may lock in a safe return given the 37-point premium on the mid-term contract.

The Junior and CNXIT don't offer such meaningful arbitrages "� in the latter case that's due to lack of liquidity in the August contract.

There is however, already lots of liquidity in the August Nifty options. The technical perspective for next week would be range-trading with a strong support at 4450 and powerful resistance above the 4570 mark. If the institutions continue to be massive net buyers in spot, the market could penetrate 4600-plus on an intra-day basis. Big intra-day ranges are likely to be registered.

The put-call ratios are uncomfortably high. In the July series, the Nifty put-call ratio in terms of open interest is about 1.85 while it is 1.83 in the August series and 0.8 in the September series, which has much less liquidity than either July or August.

In terms of actual volumes and open interest however, even September has good liquidity. While some July options have been extinguished, far more have been opened in the August and September series.

This reinforces our feeling that carryover will be good. One problem is the lack of liquidity above 4600 in the option chain "� this is perennial during an uptrend. Hence, the question of wide covered straddles and strangles doesn't arise.

In the July options segment , a long 4600c costs 12 but it cannot be covered. A bull spread with long 4550c (31.45) versus short 4600c costs about 20 and pays a maximum of 30. A decent enough risk-reward ratio but there is the expiry factor.

A bull spread with August 4600c (95.65) versus 4650c (67.6) is possible but it has adverse risk-reward ratios with a maximum payout of 19 on a cost of 31. An August long 4550c (123.15) versus short 4600c (95.65) also costs 28 and pays a maximum of 22.

A bear spread with long July 4550p (36) versus short 4500p (22.9) costs 13 and pays a maximum of 37. That's a nice risk-reward ratio but again, there is the expiry factor. A similar position with August 4550p(147.35) versus short August 4500p (133.7) costs 24 and pays a maximum of 26. That's a barely positive risk-reward ratio.

Given the technical perspective, any position inside the 4500-4600 range is likely to be hit within the next four sessions.

Since the bear spreads are more attractive in terms of risk-reward ratios, the July 4500-4550 is preferable to the 4550-4600 bull spread. If you created a covered straddle with long 4550p and long 4550c and short 4500p and short 4600c, the net cost of the position would be about 33. It makes breakeven if the market moves beyond 4517-4583.

The maximum payoff is however 17 versus an initial payout of 33 so it is not a very attractive position. The August option premiums are such that positions there seem to be rather expensive at this instant.

STOCK FUTURES/ OPTIONS

This close to expiry, there is no such thing as a viable stock option. In the stock futures market, the maximum liquidity and OI is being generated by underlyings such as L&T, RIL, RCOM, Bharti, Tata Steel and ICICI.

These are all the usual suspects and we can add DLF to the list since the new listing is already in the category of traders' favourite. There is a significant differential between L&T future (2464) and spot (2485) "� this could draw arbitrageurs who buy the future and sell the spot.

That apart, two stock positions seem interesting. One is GMR Infra which has gone through a sharp correction and seems to have bottomed. It could be ready for another up move next week.

The widening difference between future and spot may be interesting for a trader with good reflexes. The other situation is NLC, which is not generally a very liquid counter but it now has big volumes in spot and future. However, there was a lot of profit-booking in the futures segment.