Create bull spreads

DERIVATIVES

 Selling OTM puts may be worthwhile because prices are likely to reduce if the market advances

 The late surge by the market has led to a lack of liquidity in out-of-money options especially in calls.

 The Nifty closed at around 1,449 and it is very likely to continue traveling up. We could set a tentative target above 1,500 and, in case of a possible decline, there should be support at about 1,420.

 However, there are no calls or puts available above the 1,440 levels. This naturally reduces our ability to find interesting trades.

 Prices of in-the-money calls will also rise making it very difficult to find concrete trades since we cannot guess likely prices.

 For example, the 1,420c was last traded at 53 while the 1,430c was traded at 49 and 1,440c at 42. In all three cases, prices will shoot up because clear arbitrage profits would otherwise be available.

 This is why we have avoided giving indicative diagrams of potential payoffs for the various spreads mentioned below. Instead a few underlyings which look interesting have been highlighted in the charts.

 In such circumstances creating bull spreads with a standard process of buying a lower-strike-price call and selling a higher-strike-price call is impossible.

 Naturally liquidity will develop in the option chain above 1,440 strike when markets open on Monday. However, we can't guess prices.

 Given our perspective of possible moves between 1,420-1,520, we cannot really take short straddles at current prices either.

 One possibility is to create bull spreads by selling higher-strike-price puts and buying lower-priced puts. This limits our profits to the initial premium.

 For example, we can sell 1,440p (37) and buy 1,430p (32) for an income of 5 and a potential loss of 5. We can also sell puts with a lower-strike to reduce the chance of our position being triggered.

 However, liquidity in OTM puts will probably reduce although selling them may still be worthwhile because prices are also likely to reduce if the market advances. If you decide to sell puts, and you can find counterparties below 1420 levels the deals should be safe.

 Stock positions: More or less half of the entire list of stocks available in the F&O segment looked to be bullish in various degrees.

 The bullish option stocks included ACC, Bajaj Auto, Bharat Electronics, BSES, Cipla, Dr Reddy's, HCL Technologies, HDFC, Hero Honda, Hindustan Lever, Hindalco, ICICI Bank, IPCL, L&T, Mahindra, Nalco, Reliance, Shipping Corp, SBI, Tata Motors and Tisco.

 Most of these are worth buying in the futures segment. Apart from buying naked October futures, bull spreads involving the purchase of October futures and the sale of November futures is possible.

 Every October future is trading at a discount to the Friday closing spot price.

 Most November futures are trading at a discount to October futures. There is plenty of time to go before settlement on October 30.

 The normal trend during a bull-run is a further rise in the near-term future, thus creating a bigger differential between the near-term and the mid-term future.

 If the differential increases in this direction, creating a larger backwardation, the bull spread suggested above will gain.

 In the options segment we run into the same problem of lower liquidity in higher-strike-price instruments and inherent lack of liquidity in several stock options anyway.

 Once again, we have a problem with the last prices since it is very likely that prices will rise during the early part of next week's trading.

 Nevertheless we are giving the last prices as a benchmark against potential trades. In all our following recommendations, we have been restricted to the basic criteria of available liquidity.

 In ACC, a bull spread with long 210c (10.5) versus short 220c (7) is possible. This has an excellent risk-reward ratio with an initial outlay of 3.5 and potential return of 6.5.

 In HCL Tech, pick up a long 180c (10.6) and sell a short 200c (4.8) for a potential return of 13.5 on an outlay of 6.5. Selling a 180p (13) and buying a 170p (8) is also possible.

 In HLL, bull spreads of long 190c (7) and short 200c(3.75) are available and this could pay a potential 6.75 on an outlay of 3.25. In ICICI a long 210c (9.5) versus a short 220c (5.75) may be worthwhile.

 In IPCL a long 180c (8.75) versus short 190c (5) is also liquid enough. In Nalco, a long 130c (5.8) versus a short 140c (3) is available.

 In RIL, liquidity above the 448 spot price is not a problem. Buy a 450c (15.25) and sell a 460c (10). In SBI, a long 460c (14) versus a short 470c (10) is possible.

 In Telco and Tisco, long bull spreads are also available. In Tata Motors take a long 320c (13.3) and sell a short 340c (6.5) while in Tisco take a long 280c (14) and sell a short 300c (7).