Go for a bull spread

With two weeks to settlement, there is a reasonable chance for a technical bounce.

The derivatives market showed all the symptoms of a massive downtrend coupled with a narrowing of trading focus. The futures of all tradeable indices were at big discounts to the spot levels.

Put-call ratios dropped as puts came into the money and were cashed. The ten most active calls and puts were all based on the Nifty and even highly liquid stock futures saw a diminution of volumes and open interest.

Index strategies
The index futures market stayed in discount to the spot along with massive open interest expansion in the Nifty. The spot Nifty closed at 3608 while the March Nifty settled at 3,582 and the April Nifty settled at 3,580.8.

There are still two weeks to run for the settlement and there is a reasonable chance that the next technical bounce will come within that period. If the market breaks however, there is also a chance of the Nifty losing another 250 points within that timeframe.

This leaves us with a conundrum. There is little point in a calendar spread and it isn't instantly obvious how to arbitrage the spot-March future differential. If you take the view that there will be a technical bounce, you should go long. There is a considerable upside because the differential will disappear if this happens, yielding an extra 20 points.

I think the best shot is indeed to go long and keep a stop at 3,550. That leaves a downside of 30-odd points versus a potential upside of 120-170 if we assume that a technical correction could pull the index back in the range of 3,725-3,750. But it is admittedly a high risk strategy. It could be mitigated with a bear spread built on puts that hedges the possible downside.

Among the other indices, the Bank Nifty lost 5.7 per cent in spot and closed at 4,893. The March future was settled at 4881. The CNX IT closed at 5,159 while the March future was settled at 5,120.

In both cases, if you can live with margins, a long position has a fair chance of coming off. There are still two weeks to run before the settlement and there is a fair chance of a technical bounce. The upside is considerably bigger than the downside. Again, this is quite high-risk. If you decide to implement this, the Bank Nifty offers a bigger upside.

In the options market, the Nifty has a low put-call ratio of well below 0.9 at the instant. Puts have been cashed out as the index dropped while the calls' open interest has risen sharply as traders hedged or took a long position.

A low put-call ratio does of course mean that the market is overbought, which is a frightening thought, at 3,600 levels. Minimally there is a downside till the 3,550.

As far as spreads go, a bull spread with long 3,650c (53.95) versus short 3,750c (26.5) costs about 27 and offers a maximum return of about 73. A bear spread with long 3,600p (92.95) and a short 3,500p (52.15) costs 40 and pays a maximum of 60. The bull spread obviously has the better risk-reward ratios and this is the position one would advise.

Notice that we're talking about fairly wide positions "� the index has every chance of high volatility within the range of 3,550-3,750.

Spreads with a long 3,550p (71.2) and a long 3,700c (37.9) could work if there's a breakout beyond our projected range of 3,550-3,750. The strangle costs about 110 so, if it is uncovered, the profits come if the index moves beyond 3,450 or 3,800. Covering doesn't work "� the premiums are asymmetric with putts prices much higher than calls, and there is no liquidity beyond 3,500 on the downside.

Summing up, the best shots in terms of risk-reward are a long future or a long bull spread. Combining the long future with a short bear spread or a long put at 3,550p as a hedge is a possibility. But it's expensive.

STOCK FUTURES/ OPTIONS

Sadly there are no attractive arbitrages in the stock futures and options market. Liquidity has narrowed here though volumes and open interest are still good. But the focus is mainly on the top 10 stocks. The only "outsider" generating high volumes is Praj Industries "� that may be a useful long position.

In the telecom industry, there are opposed waves in Airtel and Reliance Communications. Airtel has held value during the sell off of the past three sessions and it is generating high open interest. A long position is a reasonable option.

On the other hand, Reliance Communications is taking a hammering and there is a chance the stock could have quite a major downside. This would be a decent short position.

A contrarian would seek long positions in the banking sector. At the least, this would be a high-velocity sector with rumours about the Reserve Bank's next actions flying in all directions. The actual news will come through post-settlement but there are chances of the sector being "talked up".

The best possibilities here seem to be ICICI Bank and Union Bank in the event of a technical bounce. Union Bank appears to have bottomed ahead of the sector for whatever reasons. It is likely to be an out-performer on the upside. If there is a generalised technical bounce for the sector, ICICI Bank will have to be a leader.

Among other high capitalised banks, SBI and PNB are likely to be under-performers while HDFC Bank won't out-perform the Bank Nifty.

On the basis of the latest news about Maruti, a short position could work. The stock is likely to react negatively on Monday once the implications of the government getting cold feet about selling its stake are absorbed. But this is not technically apparent as yet.