Bet on calendar bearspread

DERIVATIVES

A long September-short August position can yield excellent low-risk return if the position can be held until close to settlement.

Another week of net gains passed by although the trading patterns were rather bearish on Thursday and Friday and volumes were fairly low throughout.

The Nifty rose to test some stiff resistance above 3350. The overall market breadth was good and although trading was thin, sentiment was positive across the gamut of FIIs, mutuals, operators and retail investors.

Index strategies
The spot Nifty closed at 3356.75 while the August Nifty futures closed at 3351.8, the September Nifty closed at 3333 and October Nifty closed at 3313.25. Open interest has increased across all three series with two week still to go before the settlement.

The differential spot and the near-term series is not much - in fact, it is slightly less than the norm for this stage of settlement. But the difference between the near-term and the mid-term is quite substantial and more than one would expect to see at this stage.

For the past two weeks, we've been recommending a calendar bearspread to try and exploit this difference. That position is slightly profitable at the moment but it is worth holding till settlement week.

As stated above, the margin is low on the position and a long September- short August position would gain as the difference between the two series contracted. If this can be held until very close to settlement before it is reversed, there's an excellent chance of a low-risk return.

The other two tradeable indices have, as usual, very little open interest in the mid-term and long-term futures series. The Banknifty is trading at 4369 points in the spot and at 4362 in the August future.

The CNXIT is trading at 4353 in spot and at 4356 in the august future. Our technical perspective is that, at the moment, these two key sectors are underperforming the broader market.

There was a sell off on Friday and that sell off could continue. However the bearish signals are certainly not clear enough to allow for a confident taking of short futures positions, which would of necessity, have to be naked.

The technical perspective in the Nifty is that it's most likely to range within a about plus-minus hundred points of the current spot. There's a major support at 3250 and huge resistance at 3450.

In the options market, there has been a strong expansion in OI, much stronger than the spot market volumes would suggest. The current August Nifty Put-Call Ratio is at 1.5, which is definitely a bullish PCR. It indicates that the forward market is oversold and likely to see an upside.

As stated earlier, there's room for a move in either direction. Volatility as defined by daily high-low range, has increased slightly in the last week as well. So we could see intra-day swings of 75-100 points, which implies that either the upper or lower limits of the 3250-3450 range could be struck within a single session.

If we're considering option bullspreads on the Nifty, a long 3350c (62.45) versus a short 3400c (39.65) is almost bound to be struck and fully realised on an intra-day basis. This position costs 23 and pays a maximum of 27.

A wider bullspread with long 3400c versus short 3450c (22) costs about 17 and offers a maximum return of about 33. This position is less likely to be fully realised in a hurry but it is within our estimates. Given the excellent risk: return ratio, it is quite tempting.

On the bearspread front, a long 3350p (60.2) versus short 3300p (39.7) costs about 21 and pays a maximum of 29. This is a decent risk:return ratio. A wider bearspread with long 3300p and short 3250p (25.8) costs about 14 and pays a maximum of 36. This is a truly excellent ratio. However, support for the Nifty starts from about 3275 so, this may not be fully-realised.

If you go with a bearspread, you should probably take the one close-to-money with long 3350p versus short 3300p. If you take a bullspread, it's tempting to take the wider one with long 3400c versus short 3450c due to the better risk:return ratios.

In a range-trading situation, straddles and strangles are less likely to be effective. If you do take a strangle, take a wide position with long 3450c and long 3250p. This position costs about 48 and pays if the market moves beyond Nifty 3200-3500.

Unfortunately, it cannot be covered due to lack of liquidity beyond that range. Ideally we would have liked a short strangle of say 3100p (which is available) and 3600c (which is not). On balance, in a range-trading scenario, the strangles are less likely to work.

STOCK FUTURE/OPTIONS

There are three or four interesting industry groups which might be exploitable in the stock F&O market. There has been a sudden sharp rise in the prices of PSU refiners such as BPCL, HPCL, Kochi, etc.

This is probably speculative action in the hopes that the slight dip in global oil prices and a tinkering with the subsidy mechanism could translate into lower burdens. It's possible that the action might continue though this sort of event-based speculation is always dangerous. You could take long positions in BPCL and HPCl.

Power equipment manufacturers like BHEL and Siemens are both doing well and worth long positions. The bank sector and the IT sector both look to be in the first phases of correction. Here, taking short futures positions on individual stocks such as SBI or Infosys could work out better than short positions on the indices.

This is because you can hedge in the options market on the individual stocks. There are no hugely tempting arbitrages apparent - that is, thaere are no massive differentials between spot and futures price. Maruti and Bharat Forge also look strong and MUL offers a reasonable bullspread with long 840c(21.65) versus short 860c (14.7).