Calendar bull-spread still holds good

DERIVATIVES

The spot market is now at a premium to the futures market indicating that expectations have become more bearish.

The correction on Monday and Tuesday has led to a sea change in derivative markets attitude.

For the first time in two months, futures are trading at a discount to the spot price and, despite the recovery, there is a distinct aura of nervousness.

Index strategies
The spot market dived to lows of about Nifty 3650 before making sharp recovery. The Bank Nifty showed a much sharper fall "� this is understandable because a tighter policy on the part of the RBI sparked the correction.

The CNX IT displayed its defensive strength, closing without much change because it is near immune to changes in rupee interest rates though of course, the resultant dollar-rupee equation does affect its profits.

The spot Nifty stood at 3888 by close on Friday. The December futures contract was trading at 3870 while the January futures was trading at 3876. Through the last several weeks the futures have traded at premium to each other and to the spot.

Well, the spot is now at a premium to the futures which suggests that expectations have become more bearish. However the January future is still at a premium to the December future although the premium has eased.

Last week, we suggested a calendar bull spread going long December, short January in the expectation that the January future would soon move into discount.

This position is already slightly profitable and it's worth holding.

Of the other two tradeable index contracts, the Bank Nifty is not yet due for a complete reversal and it's possible to take a short Bank Nifty position because it could drop further.

I think the perspective on the CNXIT would be to go long "� several mid-level IT stocks and some biggies like Satyam are looking bullish and nothing is looking very bearish. These are uncovered high-margin positions however.

In the index options market, the statistics indicate something unusual. We have an extremely high Nifty put-call ratio "� it has spiked to almost 3.

That indicates that the market is extremely oversold and that it's quite likely to keep moving up in the short term at least. If we look deeper, I think it also indicates that nobody is hedging on the long side "�traders are either out or bearish in that they've taken long Nifty puts.

Bearspreads or bullspreads?
There are pricing imperfections which make this question tough to answer. A bullspread of a long 3900c (120.85) and a short 3950c (96) costs 25 and pays a maximum of 25.

The bearspread of long 3850p (125.6) versus short 3800p (102.85) costs 25 and pays a maximum of 25. That's almost exactly the same risk:reward ratios for two diametrically opposed positions. My view in the short-term would be go with the bullspread because it's that much closer to money.

The in-the-money bearspread with long 3900p (147) and short (126) actually seems to offer a better ratio with a cost of 21 and a potential payoff of 29.

That suggests there is an imperfection in the market prices. If you get these premiums on Monday, take the 3900-3850 bearspread. Otherwise, take the bullspread and be prepared to liquidate quickly if it moves into profits.

Strangles are obviously interesting because the market could swing by a massive amount if it went outside the zone of 3750-3950. There are liquidity issues however with no OI below 3800 on the put chain. If we go with a long strangle at long 380op (103) and a long 3950c (96) it costs about 200.

That position is profitable only if the market slips below 3600 or rises above 4150. I don't think this is likely inside the settlement and this position cannot be laid off due to the lack of liquidity.

STOCK FUTURES/ OPTIONS

The two sectors, which are providing a genuinely bullish impetus are IT / technology and pharma. In both sectors, stocks have continued to rise past their previous tops showing that the bearishness wastemporary.

Long futures positions in Reliance Communications, Dr Reddy's and perhaps, India Cement and Century Textiles could work. There is a lot of volume building in Century Textiles and the future (673) is at some premium to spot (668).

Perhaps there is an arbitrage here in that you can sell the future and buy the spot to lock in the difference. But it is a very low annualised return given that two weeks remain till settlement and that brokerages will eat into a significant part of the delivery position.

Bharti Airtel is also developing unusually high futures volumes and OI "� the future (614) is at a little discount to the spot (616). A long futures position here could be worthwhile.

Most interesting are the bank stocks. Until the RBI's December 8 policy , everybody was positive on the sector and the FIs were overweight. Has the long-term perspective changed? Bank stocks have recovered sharply from their December 12 lows but they are all trading below December 8 levels.

As mentioned in Micro Technicals, ICICI is likely to swing through a massive range. SBI is also looking interesting. There's a lot of OI in the stock future. SBI has dipped from 1355 (December 8) to 1261 in spot and the future is at 1269.

The perspective appears to be positive in the short term but there's a likely downside till about 1220 before the end of the settlement. My suggestion would be a short future and along call-bullspread or the other way around.