Go for bear-spread

DERIVATIVES

A bullspread is more likely to work but the payoff for a bearspread is high enough to compensate.

The market made a classic v-shaped move last week, dropping for three sessions and then more than recovering the lost ground in the next two sessions.

The Nifty has now risen to a new all time high and trend has clearly turned bullish again despite net selling by both FIIs and mutuals. There is still a fortnight to go for the settlement so there is ample time to exploit the sentiment.

Index strategies
The Nifty has risen to an all time high of 4052 in the spot market. On Friday, the January Nifty contract was settled at 4059 while the February contract was held at 4058. Open interest increased across both contracts.

Obviously, there is no chance of a calendar spread that arbitrages non-existent variations in futures prices.

In practice, given a bullish trend, the near-term January contract should rise relative to the medium-term contract next week and in settlement week, the prices will converge again.

If you wish to exploit this, you may take a calendar bullspread with a long January "� short February profile. If premium develops in favour of the near-term contract, this low-margin spread will gain.

Among other indices, the CNX IT somewhat outperformed the broader market last week. This wasn't surprising. The rupee was slightly weak, which is always a trigger for IT bulls.

Also the entire bull-run was driven first by Infosys's excellent Q3 results and guidances and then, by punters going long on TCS, Polaris, etc. in the hopes of decent results. So a long CNX IT position is possible "� this is high margin.

The January CNXIT future is trading at 5601 while the spot is 5598. Again, this is hardly a difference worth trying to find an arbitrage play.

In the options market, premiums have stiffened on both sides of the put-call chain as volatility has also increased. Open interest in calls has dipped significantly over the past two sessions.

As the market rose, bears who were hedged against shorts elsewhere through long Nifty calls, have rapidly covered their shorts and cashed their long calls.

As a result, the Nifty put-call ratio has risen to about 1.45. This indicates an oversold market and hence, the bullish trend is somewhat more likely to continue.

Due to the uptrending nature of the market, close-to-money call premiums have jumped relative to CTM put premiums This means that the risk:return ratio for calls is less favourable than puts. Our perspective is that the market is more likely to continue rising through next week.

However, even a small intra-day fluctuation might lead to bearspread being struck and the risk:reward ratios are sufficiently favourable for us to recommend contrarian bearspreads.

To recap: a bullspread is more likely to work but the payoff for a bearspread is high enough to compensate.

In concrete terms, a long 4050c (61.6) versus a short 4100c (38.45) offers a maximum payout of roughly 27 for an initial outlay of about 23. This is not a bad ratio for a position that is already in the money. This will be profitable f the market rises to about 4080.

However, a bearspread constructed with long 4050p (52.9) versus short 4100p (36.75) costs about 16 and pays a maximum of 33-plus. That's a terrific risk:return ratio for a position that is very close to being in the money. In effect, this position becomes profitable if there is an intra-day drop of just 20 points.

We can also try to construct straddles and strangles to cater for possible two-way movements. There is no liquidity in the option call chain above 4100 so let's say that we take a straddle with a long 4100c (38.45) versus a long 4000p (36.75). The position costs about 75 and it cannot be laid off on the upside.

On the downside, we may lay off the strangle with a short 3900p (20.7). That leaves a "semi-capped" strangle, which costs 55.

This position will be profitable if the market rises beyond 4160 or drops below 3945. A "dip" would yield a maximum of about 45. Volatility has risen in the market. This position is quite tempting. We've mapped the long strangle with long 4000p and long 4100c without tracking the possible layoffs.

STOCK FUTURES/ OPTIONS

There are several highly interesting plays on the long-side in the stock F&O section. On the short-side however, there isn't much that is technically attractive.

Rumour-mongering is naturally rife because we are in results season. Refining seems a key play. The best picks for a bullish player might include long futures in BPCL and in RIL. The Hutch story has already caused upheaval. Prices of RComm and Essar have both risen and fallen on the basis of unclear company statements and wild rumours.

Bharti is seeing a lot of action. Interestingly, MTNL has also jumped though this has more to do with rumours of better results, than Hutch-Essar.

ICICI and UTI Bank would be primary choices for anybody seeking to exploit the loosening of regulations on the SLR front. Other banks will surely follow suit in being bid up "� hDFC Bank could also be a good shot.

Among other stocks, TCS, Tata Power, Wipro, IFCI and Polaris Software are seeing enthusiastic bull support. Each of these is supposedly poised to display formidable Q3 results that will surprise an already-bullish market.

TCS and Polaris seem to be the most credible. But IFCI will probably be the "hottest" in terms of payoffs. It's a turnaround and also relatively low-priced. It's already risen about 50 per cent in the past week.