Better pay-off in bull-spread

DERIVATIVES

The bull-spread is much closer to the money and also the "long-leg" is cheaper.

The F&O market is looking jittery and narrower than usual with prices fluctuating rapidly and a disappearance of interest in less liquid contracts. This could be a sign of a change in the intermediate trend. However there hasn't been a dip in liquidity as such "� it is more a concentration on specific contracts.

Index strategies
The spot Nifty closed at 4145 on Friday with the June contract held at 4122 and the July contract held at 4119. OI expanded in both contracts. The CNX-IT went up 1.3 per cent to close at 5338 in spot while the June CNX-IT closed at 5330.

The BankNifty lost 3.55 per cent in spot to close at 6177 while the June future was held at 6160. There was a sharp decrease in OI probably as long players cut losses and shorts booked profits. Both BankNifty and CNX-IT have only nominal OI in the July contract.

The futures in these two contracts very rarely trade at discount to the spot "� it is a sign of highly bearish expectations. Even more unusually, where the CNX-IT is concerned it is coming in a week where the index has risen and the fundamentals have improved marginally due to rupee softening. If we assume that CNX-IT will align with a generally bearish market, it may be worth a short.

The Banking sector is definitely under pressure with selling across the board. The long-awaited ICICI FPO may be a pivot "� but the details are still awaited. If you can bear the margins, short the BankNifty as well!

The differential in favour of spot Nifty versus the future may also be read as a sign of extreme bearish expectations. This large a differential is unusual. It would be normal to expect this to correct one way or the other.

Unfortunately, it isn't easy to exploit spot versus near-term contract. You would have to sell a Nifty basket in spot and buy the future "� much too complex. If you can hold calendar spreads fairly late into the settlement, sell the June contract and buy July. In a bearish market, the mid-term contract will develop a premium.

In the index options section, the new contracts in the Nifty Jr and the CNX 100 have not developed any volumes yet. This is a pity because the Jr has outperformed the Nifty itself in the past 12 months and the past 3 months as well.

In the Nifty options market, OI has expanded considerably in both puts and calls, but more in the latter. The put-call ratio is down to 1.26 now "� this is still a fairly bullish reading. If the market does drop further, there could be a sharp decline in put OI as profits are booked.

Technically, the Nifty could either recover till 4225 or drop till 4050 if the trend worsens as looks likely. There could be a liquidity problem early next week as the DLF issue hits the market. Either way, on a one-week perspective, assume the Nifty will move somewhere,between 4050-4225 and the downside bias is more likely.

A bull-spread of long 4150c (85.9) versus short 4200c (64.2) costs 21 and pays a maximum of 29. A bear-spread of long 4100p (92.7) versus short 4050p (71) costs 22 and pays a maximum of 28. Not much difference in terms of risk:reward ratios.

However, the bull-spread is much closer to the money and also the "long-leg" of the bull-spread is cheaper. So, it may be worth a shot. If you decide to take that, be prepared to hold for longer than a week. Sometime within the settlement, it should pay even on a temporary bounce. If you decide to go with the current trend and take a bear-spread, consider the in-the-money position of long 4150p (115.4) versus short 4100p (92.7).

That costs 23 and pays 27 so it's practically the same as the out-of-money position. The similarity in payoffs leads one to suspect that the 4150p premium could shoot however.

In terms of strangles, a long 4050p (71) versus long 4250c (45.3) costs 116. So the breakeven comes if the index moves outside 3920-4370. The downside of this position appears more likely than the upside at least within the settlement.

STOCK FUTURES/OPTIONS

Apart from the IT sector, only three stocks appeared to be bullish mode. GMR Infrastructure. Hindalco and Praj Industries may be worth long positions. In the IT sector, there is a strong bounce that has had a positive affect on Satyam, Infy and TCS among others.

However this may not be sustainable unless the rupee continues to soften. If you do go long in IT shares, please keep tight stops or consider a partial hedge with a short CNX-IT position as well.

On the short side, the PSU refiners appear to be obvious targets as does the auto sector. Bajaj, Hero Honda and Maruti appear to be fairly safe short positions in the context of the next five sessions.

A dark horse could be ONGC which is showing signs of bottoming. Since early June ONGC has dropped from 900 levels to about 830 before seeing a turnaround and recovery to close around 852. Note the continuous discount to spot. It has the potential to rise till around 885 though this could be a "dead-cat bounce". Keep a stop at 841 and go long.

There may be also an arbitrage position opening up in Reliance Capital where the spot (965) has dropped further than the future (970). This could mean some buying in spot coupled to selling in the future.