Bullspread looks good

DERIVATIVES

Since there is good support at Nifty 3120, a bullspread would work better than a bearspread.

The indices closed up after an eventful week, which also featured a massive one-session correction and extreme volatility. Next week should see a continuation of the bull-run, but there could be massive intra-day volatility even if there are net gains week-on-week.

On the downside, a dip till Nifty 3120 levels is not unlikely while there could be a test of the projected upside target of 3250 as well.

Index strategies
Before we get into details one basic point should be borne in mind. Implied volatility at the moment with respect to option premia is relatively lower than the actual volatility during the last week. This suggests that we should be extremely cautious about option writing "� the premium income is probably not worth the risks.

The cash Nifty closed at 3184 on Friday. While the March Nifty future is at 3166.45, the April future is at 3161 with over 10 lakh in open interest and the May future is at 3147 with over 2.45 lakh in open interest.

There are several tempting possibilities with these differentials. None of these positions is mutually exclusive "� they could all work in the same week of trading.

One is an obvious long March future under the assumption that the differential between cash and future will narrow. This could work even if the market does not see large net gains.

A second possibility is a calendar bullspread of long March-short April. This works if the differential between the two series increases "� at this stage of a settlement, there is usually a somewhat greater discount of around 8-10 points in favour of the near term. A third possibility is a calendar bearspread of short April-long May.

This would work if the differential between April and May narrowed. Normally, the far-term future is not worth trading on account of lack of liquidity, but that is not the case at the moment. This position can be carried over past the March 30 settlement.

In the options market, as already mentioned, IV appears to be lower than warranted by the movements of the past two weeks. The Nifty put-call ratio is at 1.74, which is higher than it was last Friday.

Traditionally, a high PCR is supposed to be the sign of an oversold market, but this relationship has not always worked in the Indian market where PCRs are consistently high. The PCR was actually higher on Tuesday and Wednesday, just before the sell-off.

A Nifty bullspread of long 3200c (40) versus short 3250c (21.5) costs 18.5 and pays a maximum of 31.5. That's an excellent risk-return ratio. A Nifty bearspread of long 3150p (49) versus short 3100p (31) also costs 18 and pays 32. That's an even better ratio.

As a trader, you could take a view and accept either position. In technical terms, the bearspread is somewhat less likely to be fully exploited because there seems to be good support at around 3120. So, on balance, the bullspread is probably a little better.

If you decide to look for a strangle, a long 3200c and long 3150p costs a prohibitive amount of 89. This position would be profitable only outside 3060-3290. It could be hit before settlement, but the returns are not commensurate with the risks.

I would hate to be anything short of close to money in a situation of likely volatility and relatively low IVs. A wider strangle of long 3250c and long 3100p costs about 53 and pays off if the Nifty moves beyond 3045-3305. Again, this does not seem like a great position.

The March bank Nifty future closed at 4636 while the cash bank Nifty closed at 4656. This differential is worth a punt on a long bank Nifty with the additional buffer in terms of most major banks appearing to be technically bullish.

The CNXIT closed at 4082 while the CNXIT March future closed at 4094. The situation is exactly the reverse of that in the bank Nifty. In theory, you should buy the heavyweight constituents of the index in the cash segment and short the index future.

This is cumbersome and there is not much OI in the future. There also seems to be a generally bullish flavour to IT stocks. So, we could deal with those in the futures or cash segment and, regretfully, ignore the index future itself.

STOCK FUTURES/OPTIONS

There are a whole lot of stocks that are looking bullish. It makes sense to focus on the futures segment because liquidity in the stock options market is usually low.

However, there are some option possibilities as well. Almost every IT major moved up sharply, with Infosys, Satyam, TCS and I-Flex all looking good. Many major banking stocks also looked bullish.

Majors such as SBI, PNB, ICICI and Bank of India all have promising formations. Apart from these, ABB, ACC, Bajaj Auto, Bharat Forge, Dabur, Gujarat Ambuja, Hindustan lever, Hero Honda, MTNL and Tata Chemicals also showed bullish formations.

You could randomly pick a few stocks from these three sets and go long in the futures segment. In the options segment, Infosys offers a fairly good risk-return ratio with a long 2950c (51.75) versus short 3000c (32.5). However, this spread is in the money only if the market moves some Rs 60 up from the current spot price.

TCS also has decent option liquidity. A long 1770c (39.95) versus short 1800c (29.95) costs 10 and pays a maximum of 20. That is a good return-risk ratio and it is quite close to spot (1763). Bharat Forge also offers an interesting possibility with long 480c (14.15) versus short 490c (11).

The ratio is excellent, but the 490c has low OI, which suggests that the price could change quickly. Also spot is at 471, so it would take a significant advance to fully realise this position.