Excellent carryover patterns

The September segment is offering fairly attractive spreads for option traders.

Huge volumes and strong carryover patterns characterised derivative trading last week. Traders appear to be expecting a continuation of range-trading since a lot of winning calls were cashed out on Friday.

Index strategies
On Friday, the derivatives segment generated over Rs 80,000 crore, which is excellent even for the last low-margin day in a settlement. Open interest in the Nifty futures contract has expanded by over 45 lakhs, which is quite impressive. Over 30 per cent of the Nifty futures OI has already moved into September or beyond, which is also unusually high. Carryover also looks to be reasonable in the Bank Nifty where incidentally the August series is trading at noticeable premium to the spot. This premium could imply a potentially bullish move in the Bank Nifty. The CNXIT hasn't developed serious carryover yet but it has a recent history of outperforming the Nifty. This could be accentuated due to the rupee-weakness that has been apparent late this week.

Since the FIIs have toned down their derivatives exposure, this volume explosion must be driven by Indian operators. They took advantage of a burst of short-covering on Friday to cash in on winning August calls. Coupled to an expansion in put OI, this has pulled what was a bearish put-call ratio back to neutral levels.

The overall Nifty option PCR is around 1.1 while the August PCR is slightly higher. The Nifty option OI also shows a strong carryover pattern with over 45 per cent of volume having moved into the mid-series and beyond.

The last fortnight's range-trading seems to have convinced traders that a breakout, or at least an upside breakout is unlikely, going by the hasty profit-booking in calls. This has interesting implications. If the market does rise beyond 4,625, there would be a sudden focus on calls above the 4,700 level, which could have exaggerated effects on premiums in the midst of the settlement process.

One effect of the carryover has been that the September segment is already offering fairly attractive spreads for option traders. While premiums will drop post-settlement, the spread risk-reward ratios may actually be better right now, than they will be five sessions down the line. This mitigates the usual expiry effect, where spreads close to money seem to have terrific risk-reward ratios in the last week but there is massive deterioration farther from close to money.

Compare the risk-reward ratios for August and September option spreads. A bullspread with long Aug 4,600c (39) and short Aug 4,700c (14) costs 25 and pays a maximum of 75. A bearspread of long Aug 4,500p (50) and short 4,400p (24) costs 26 and pays a maximum of 74. These are both typical high risk-reward ratios for positions that will only be "live" for four sessions.

Combine the above, and you're talking about a net cost of 51 for a position, composed of one long and one short strangle, that pays a maximum of 49. Roughly a 50-50 shot for a move of 125-175 points from the money. The Nifty has been swinging about 125 points per session so this could be a reasonable play despite expiry risk.

Now, a September bullspread of long 4,600c (157) and short 4,700c (116) costs 41 and pays a maximum 59. A wider bullspread of long 4,700c (116) and short 4,800c (81) costs 35 and pays a maximum of 65. These are decent risk-reward ratios for positions that will last till September 24.

Similarly, a September bearspread with long 4,500p (169) and short 4,400p (128) costs 41 and pays a maximum of 59 while a long 4,400p (128) and short 4,300p (98) costs 30 and pays a maximum of 70. Clearly if a trader is looking for positions somewhat wide of the money, September spreads seem to be a good proposition.

Straddles or strangles seem too expensive in the September series. A long September strangle of long 4,400p (128) and long 4,700c (116) costs 244 but the net cost can be reduced to 153 by setting up a short strangle of short 4,100p (50) and short 5,000c (41). This has breakevens at 4,247, 4,853 and a maximum return of 147.

One way to try and exploit an expiry situation is to sell options far from the money and create "reversed spreads" where the trader sells a call or put closer to the money and covers it with a long call or put further away. The idea is to pick up the premium from the short sale and hope the market doesn't swing enough to strike the position.

This will generally have adverse risk-reward ratios but it's worth doing in circumstances where it doesn't seem like the market will move enough to strike the position. It could work in these circumstances where the market is range-trading and the volatility is medium rather than high. For example, a reversed bearspread of short August 4,700c (14) and long 4,800c (5) results in an initial premium flow of 9 and could mean a maximum loss of 91. Breakeven is at 4,709. Similarly a short Aug 4,400p (24) and long 4,300p (11) pays an initial 13 and could lose a maximum 87.

 

STOCK FUTURES/OPTIONS

Most stocks seem to be exhibiting behaviour similar to the major indices in that they are range-trading and tough to read for direction. However, a few trending moves seem to be on the cards though these are all in relatively less liquid contracts.

Aban is trending up and so are Idea and IVRCL Infra. These three futures have adequate liquidity and good carryover so going long in any of them is a possibility Among more heavily traded counters, Suzlon has developed a bearish intermediate pattern, with falling tops and a short may pay off here.