Bet on calendar spreads

DERIVATIVES

A long March future versus short April future could produce a positive return if the differential between these two series widens.

The sharp correction on Friday has set up an interesting settlement week. Apart from the nervousness caused by the sell-off, the settlement will also be dominated by the anticipation of volatility in the next settlement due to the Budget.

My view is that this correction will probably ease off in mid-week at a low of around 2950 and that will be followed by a pre-Budget rise in prices. If the 2950 is broken, the next support is around 2915.

Index Strategies
The spot Nifty is at 2981 with the February Nifty Future at 2978, March Future at 2968 and April Future at 2963. There is a fair amount of OI in all three instruments. The Nifty put-call ratio for February instruments is quite high at 1.65 although it has come down from the previous week when it was ruling above 1.85.

This PCR suggests that the market is somewhat oversold "� in a bullish scenario, a high PCR is easier to ignore because it is due to hedging. In a bearish scenario, (which is how most traders will read the market after a 1.5 per cent drop last week) many of the puts will be speculative, rather than hedges.

In the futures segment, a 10-point differential with four sessions to go for settlement is reasonably significant. A bear-spread with short February futures versus long March futures should fetch a positive return since that differential must disappear on Thursday.

Given the relatively low differential between March and April and good liquidity, another calendar spread is possible. A long March future versus short April future could produce a positive return if the differential between these two series widens.

That's quite likely and it will definitely happen if the rollover comes in a rising market. If you take this March-April spread, be prepared to close out the position in a hurry because of the unpredictability of Budget session movements.

In the options market, a bullspread with long 3000c (21) versus short 3020c (13.6) costs about 7.5 and pays a maximum of 12.5. There are the usual caveats about being close to settlement since these are wasting instruments.

A bearspread with long 2950p (20.5) versus a short 2900p (8.25) could in theory, fetch a huge return of 39 for an outlay of 11. However this position is comparatively far from the money and even if it is struck, it is unlikely to be full realised.

Unfortunately, there isn't enough liquidity in between 2900-2950 and between 2950-2980 for us to develop a bearspread with a shorter range. There are still a massive number of 3000p outstanding "� this in-the-money instrument last traded at around 42 so, there hasn't been a cash-in.

In the context of the Budget, it's useful to look for a couple of March positions. A bullspread with long March 3050c (57) versus short 3100c (41) costs about 16 and pays a maximum of 34. That's a nice risk:return ratio and there's ample liquidity at these strikes already. So we could recommend this position, which would work very well in a post-Budget bull run.

We can also take up a March bearspread with long 2950p (92.5) versus short 2900p (73) because there is enough OI at these strikes. This position costs 19.5 and pays a maximum of 30.5. That's a decent risk:return ratio once again and the position would work in a post-Budget crash.

Historically there is usually a 3-5 per cent in the Budget week though the direction is unpredictable. So we should also look at strangles. A long 2950p versus long 3050c costs a total of 148 however. That is a little more than one would be willing to pay. If this position can be laid off with a wider short strangle such as a short 2850p (55.5) and a short 3130c ( 37.5), our total outlay would be around 55.

Then the long strangle-short strangle combination would be in profit if the market moved between 2850-2895 on the downside or between 3105-3130 on the upside. The risk:reward ratio is marginally adverse, though the likelihood of the position working is quite good.

Apart from the Nifty, it is actually possible to take a punt on both the CNXIT and the Banknifty since both these indices appear to have clear short-term trends. One could go long in the CNXIT futures and short in the Bank Nifty. These are naked speculative positions of course. Set a stop at 4575 for the Banknifty and a stop at 3875 for the CNXIT.

STOCK FUTURES/ OPTIONS

Forget about stock options for the moment. There isn't enough liquidity in the March settlement to make options worthwhile and expiry is just around the corner in February.

We could look at short-term stock futures positions in February. There are positions possible in both directions. One could recommend short positions in ONGC, Hindalco, Bank of Baroda and PNB. Long positions appear to be possible in Infosys, Wipro, NDTV and Dr Reddy.

Rollover presents an interesting problem in the stock segment. Generally Budget-related moves are sector-specific and often, they turn into broad marketwide trends. Perhaps the best trading strategy is to target a small population of high-beta stocks and trade these after we know the thrust of the Budget.