Bull spread seems good

DERIVATIVES

A bull spread of long 3750c versus a short 3850c costs about 35 and could pay up to 65.

The massive swings on the spot market naturally translated into equally wild swings in the futures and options segment. Volumes in the F&O segment expanded dramatically "� quite a bit more than on the spot markets.

However, interest had narrowed down quite significantly to index instruments on Friday's session. March is a long settlement, so traders will get an opportunity to hold losing positions and hope against hope for a bounce-back.

Index strategies
The spot Nifty closed at 3726 while the March Nifty future was held at 3690.30 and the April Nifty was settled at 3696.20.

The CNX IT closed at 5190.10 in the March futures series and at 5200.60 in the spot. The Bank Nifty was settled at 5207.25 in the March futures and at 5218.95 in spot. Open interest expanded in all four series.

The massive discount to the Nifty spot in the futures series is a sign of consensus expectations. It is also an opportunity since the market looks oversold "� a naked long position in the Nifty could actually pay off.

The premium on the April future versus March is also unusual and a sign of bearish expectations. However the differential isn't much and, if the market does bounce, the premium is likely to turn into a discount. So if you believe in a technical recovery, a calendar bull spread with long March and short April may also make sense.

The other two indices are also at discounts but the technical positions are difficult to read. It's difficult to conceive of a market-wide recovery that excludes these two sectors but it could happen. I would be more comfortable being long on the CNX IT than on the Bank Nifty since financial stocks are always dicey in a regime of rising rates.

In the options segment, the Nifty has a put-call ratio (PCR) of close to 1. This is low and on the face of it, it signifies an overbought market.

However, the pattern of the last year's trading has been such that one assumes there is a fair amount of hedging with long Nifty calls open versus open short positions in other instruments. Despite the low PCR, the other signals are such that one assumes the market is oversold. A technical bounce is very likely but it may not last.

Last week, for example, we had contemplated a hedged position composed of a short Nifty future at about 3950 coupled to an options bull spread of long 3950c and short 4100c. People who did take this or similar positions going into the budget will have made a large profit.

They should book the futures profit and also extinguish the 4100c with an ulta sauda, while hanging onto the long 3950c. This sort of strategy is probably causing the low PCR.

A bull spread of long 3750c (79.9) versus a short 3850c (45.3) would costs about 35 and pay a maximum of 65. A bear spread with a long 3700p (117) can be initiated but the crash has been so rapid, there is no liquidity below 3660p (95.2).

This costs 22 and pays a maximum of 28. That is a reasonable risk-reward ratio but not as good as the bull spread. At the risk of sounding hopelessly optimistic, the recommendation is to take and hold the bull spread. It has four weeks to pay off and it will just take a 2 per cent move.

A long straddle or strangle is prohibitively expensive and it cannot be laid off due to the lack of liquidity on the downside. That's a pity because it would be the ideal instrument in a volatile market where large intra-day swings can be expected. Precisely due to the high volatility and the inability to lay off, a short strangle is very dangerous.

At this instant, the best position in terms of risk-reward is therefore the bull spread. Liquidity should develop quickly on the downside and then, traders can explore the possibility of bear spreads and straddles or strangles.

The market is likely to remain volatile with a wide intra-day range through the entire settlement. While it could have sharp, sudden upswings the net movement is likely to be down.

STOCK FUTURES/ OPTIONS

The stock F&O segment has narrowed down. There is almost zero liquidity in the stock options segment so we can forget about those positions.

Even in stock futures, the open interest is lower than one would expect at this moment although daily volumes have been excellent. This means the market is currently dominated by scalpers or intra-day traders who enter and exit with tight stops looking for minuscule profits.

As mentioned in the Macro and Micro Technicals, more stocks appear poised for a bounce than for a continuous slide. Therefore one would recommend long futures positions mostly but with a short time-frame and very tight stops.

The two sectors which appear most promising technically are power equipment manufacturers consisting of ABB, Bhel, Siemens and Suzlon, and pharma where the movement is quite widespread with Wockhardt, Ranbaxy, Dr Reddy's, Sun and Aurobindo all looking bullish.

Apart from these, there are scattered possibilities such as Hero Honda etc. One set that could still be worth shorting is the metals sector "� Sesa Goa in particular, though Sail and Tata Steel also look shaky.

There is an apparent flight to safety into telecom service stocks such as Bharti Airtel and Reliance Communications "� these could offer reasonable long positions.

The dark horse could be Praj Industries, which has fallen massively as short positions unwound. It may have bottomed and become worth a long position. Both Bharti and Tata Steel offer arbitrage potential with the respective futures trading at over 1 per cent premium to spot.