Expect volatility

DERIVATIVES

The March bull spread and April bear spread offer excellent risk-reward ratios.

There will be a fair amount of excitement going into the settlement because of the massive bounce that occurred last week. It's likely to be a week of huge intra-day movements and wild fluctuations in premiums.

Index strategies
The spot Nifty closed at 3,861 after gaining about 7 per cent. The March Nifty settled at 3,869.35 while the April Nifty was held at 3,865. There is already a switching of positions evident in the open interest as the numbers sharply decreased in the March future while the April future saw strong open interest expansion.

In the other indices volume hasn't built up yet in April and open interest expanded in (not very liquid) March CNX IT while it decreased in the much more heavily-traded Bank Nifty. The Spot CNX IT was at 5,370 while the future was settled at 5,368. The Bank Nifty spot closed at 5,519 while the future was settled at 5,512.

The differentials are very minor and not worth trading so calendar spreads are out. Any positions are strictly dependent on your views of where the index is likely to trade and trend.

In all three instances, there is a potential upside of about 1-2 per cent and a potential downside of about 2-3 per cent. Thursday's trading is make-or-break. It could be strong because of last moment short-covering by bears who are still hoping to make a major killing.

The Nifty options market is naturally spooked by settlement considerations. There is considerable open interest in the April segment already and it expanded by huge amounts last week. In the April segment, the Nifty put-call ratio is marginally over 1 "� that is overbought by normal standards.

In the March options as well, open interest continued to expand on Friday "� unusual going into settlement week. The put-call ratio is also marginally over 1 "� once again, a slightly overbought position.

This feeling is reinforced by the fact that Friday's open interest expansion featured almost four times as many outstanding puts (across March and April combined) than outstanding calls. The position on Thursday, March 22 was very overbought. That has been somewhat mitigated by a sell-off on Friday.

The correction that started on Friday could continue early next week. Our expectation is that there will be support coming in at 3,750 and selling at above 3,900. The market may swing between 3,725-3,925 without finding a conclusive trend. If it closes above 3,925 or below 3,725, a trend is likely to be clearly established.

In the index options market, March bull spreads with long 3,900c (29.75) versus 3,950c (15.8) cost about 14 and pay a maximum of 36. A March bear spread of long 3,850p (36.5) versus short 3,800p (18.85) costs 18 and pays a maximum of 32.

The looming expiry presents some danger but both these positions have excellent risk-reward ratios and they're likely to be struck.

However, the bull spread is further from the money and less likely to be fully realised. So considering March settlement in isolation, our vote would go to the bear spread despite its less favourable risk-reward ratio.

In the April segment, a bull spread with long 3,900c (105.75) versus short 3,950c (81.95) cost 24 and pays a maximum of 26. A long 3,850p (113) versus short 3,800p (95.6) costs 17 and pays a maximum of 33.

Here again, the bear spread is much more tempting. If you can handle the high pricing, the risk-reward ratio is great.

Taking everything into consideration, a March bull spread with its excellent risk-reward ratio and an April bear spread with ditto seems the maximal strategy.

The March spread is highly risky due to the expiry factor but there is a fair chance of it being struck intra-day at least. The April bear spread seems almost riskless in practice.

STOCK FUTURES/ OPTIONS

Forget about the options segment with stock underlyings. There aren't any situations that look tempting enough to risk expiry in a market with generally illiquid instruments. Of course, liquidity isn't a problem with futures.

There is one potential arbitrage in ICICI Bank. The future is at 890 with the spot closing at 895.5. If you can sell the spot and buy the future, that locks in the profit with a four-day perspective. Of course, this means having prior delivery on the stock.

The other really interesting technical position is Reliance Industries. The spot closed at 1,376 while the future was settled at 1,377. That's not an arbitrage position. But the April future was settled at 1,388 "� the differential should narrow by settlement date. Hence a calendar bull spread is possible. A long March future coupled to a short April future will gain if the difference narrows.

The RIL stock looks technically capable of a big move this week. It could go to either 1,340 or 1,410 if it develops a sense of direction. Hence, another suggestion is a simple short March future coupled along with an April option position.

This would work if the stock lost ground in the short term and then picked up steam. The relevant April 1,380c (43.65) and 1,410c (29.75) are a little expensive. But premiums should drop near switchover especially if the stock dips.

Apart from these, long positions in BHEL, Mahindra & Mahindra and Maruti are fair tries along with Hindustan Lever and SAIL. None of these are exceedingly compelling, so bear the expiry danger in mind before taking a position. In the bank sector, we have apparently secular bull trends in Kotak, Corporation Bank and UTI Bank.

All look quite tempting. The danger here is that, when the bank sector moves, it tends to move together and a 12 per cent rise is likely to be followed by some profit-taking.