Bull-spread looks safe

DERIVATIVES

The discount in the futures market suggests neutral or bearish outlook.

The market continues to test resistance above the Nifty 3200-mark. Thus far, it's been unsuccessful but it did make net gains last week and it's managed to trade above the benchmark 200 DMA.

The intermediate trend has been positive since mid-June so it's into week no:7. Intra-day volatility has eased a bit and the volumes in the new settlement have been lacklustre.

Index strategies
The spot Nifty was last traded around 3176, while the August Nifty future was at 3167, the September future was at 3145 and the October future was at 3131. Open interest (OI) increased in all series but not by very significant amounts. Spot market volumes were also low.

Our technical perspective is that the market would be poised for a big move if the Nifty did manage to close above 3250. On the downside there's a lot of support at the 3075-3125 band.

The likeliest situation is that the Nifty will continue to move inside the narrow band of 3125-3250 without a decisive breakout in either direction.

The discount in the futures market suggests that consensus opinion is neutral or bearish. The differential between August and September is still significant though its lower than it was last week.

A calendar bearspread with long September Nifty "� short August Nifty should be a safe enough way to exploit the differential. Whatever the market direction, this difference is likely to reduce and it's a low-margin position.

So far as the other tradeable indices are concerned, OI increased somewhat but the liquidity at this stage is no more than adequate.

The BankNifty seems ripe for a downwards move in technical terms because several major bank shares went into sell-mode on Friday after across-the-board interest rate hikes.

The spot Banknifty was last seen at 4067.75 while the August future is at 4059. Obviously this would be a naked sell so the risk is considerable.

The CNXIT shot up by over 3 per cent last week. The spot CNXIT is at 4198.4 while the August futures are trading at 4202. Our technical perspective on the CNXIT is mildly bullish but this is not likely to be a really exceptional week for IT shares. The position is too ambiguous for the index to worth trading in a naked high-margin situation.

In the options market, there was a healthy expansion in OI across both the Nifty put and call segment. The Nifty Put-Call Ratio rose to above 1. This is a sign that the market is mildly oversold and hence, slightly bullish.

As stated above, there's unlikely to be a great deal of volatility. However if the Nifty does move above 3250 or below 3075, it would set a strong new trend.

A standard bullspread with long 3200c (85.4) versus short 3250c (62.85) would cost about 22 and pay a maximum of 28. That's a reasonable risk:return ratio. A wider bullspread with long 3200c versus short 3300c (44.85) costs about 41 and pays a maximum of 56.

There isn't much to choose in terms of risk:return. Given our perspective of narrow movements, wide bullspreads don't appear worth taking.

We can however, examine the long 3250c versus short 3300c position because that offers the best risk:reward as the position costs about 18 and pays a maximum of 32. However, this will only work if there's a genuine breakout.

In terms of bearspreads, a long 3150p (94.5) versus short 3100p (72.1) costs about 23 and pays a maximum of 27. This is practically the same risk:return equation we get with a bullspread at a similar distance from money.

A wider bearspread with long 3150p versus short 3050p (56) costs 38 and pays a maximum of 62. This is a somewhat better ratio than the equivalent bullspread. The long 3100p versus short 3050p also offers a marginally more favourable risk:return ratio than the equivalent bullspread.

We have a liquidity problem and an absence of quotes beyond the 3300 strike-price. This restricts our ability to take strangles or straddles since we cannot lay off the position. If we go with a strangle of long 3300c and a long 3050p, the position costs about 101.

This would be profitable only if the market shot beyond either 3400 or 2950. Given the currently low volatility and our inability to hedge on the upside, these positions are best avoided. Short strangles are actually tempting due to the lack of current volatility but once again, our inability to hedge makes these rather dangerous.

STOCK FUTURES/OPTIONS

Very few stocks appear independently bullish. And, not too many stocks appear to be clearly bearish either. Bank shares form the only set, which seems likely to move down as a group. You could go short on SBI, Syndicate and PNB if you prefer these individual positions to going short on the Banknifty.

On the long side, Dabur and Bharti Airtel are the best stock futures if you want to take long positions. TCS, Nicholas and Ranbaxy may also be worth punts on the long side.

In terms of arbitrage, there aren't particularly large differentials available between spot and futures prices. Among active contracts, the ACC future is trading at 866.5 while ACC spot is at 860.5. This may be worth trading with a short future and a buy of the spot but the return will be quite thin.

In SBI, with the spot at 807, a bearspread may be worth taking with a long 800p (24.7) and short 780p (19). The net cost is about 6 and the potential return is about 14. The other potential bearspread is in Reliance with the spot is at 968 and the stock looking slightly weak. A long 960p (25.8) versus short 940p (17) costs about 9 and pays a maximum of 11.