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| Put-based bear spreads should be prefered as their risk-reward ratio looks favourable |
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| Our market perspective for the week is a small further reaction followed by range trading. |
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| In all probability the Nifty will find support at around 1620 and then consolidate within the range of 1620-1690. |
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| There is a small possibility that, if the 1620 support is broken, then the Nifty could drop till around the 1580 levels. Liquidity will not be a problem for December instruments since the index has already traversed this entire range. |
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| The Nifty put-call ratio is more or less neutral at current levels of 0.38. It would be reckoned oversold if it goes past the 0.45 mark. |
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| There is an appreciable premium on the January Nifty which is trading at 1651 versus December Nifty at 1645 and the cash market at 1645. |
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| If we trust our perspective, it makes sense to buy December and sell January. The gap between December and January should close. |
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| In the options market, we could look for close-to-money short-term bear spreads that would be profitable if the market does fall further. |
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| We could also look at slightly longer-term bull spreads designed to benefit when the market consolidates. Or, we can combine the above possibilities with straddles or strangles. Let's look at ctm unidirectional combinations first. |
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| Right now, a bear spread with long 1630p (23) coupled to a short 1610p (16.6) has a potential payoff of 13.6 versus an outlay of 6.4. |
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| A bull spread of long 1650c (31.5) versus a short 1670c (22) offers a possible payoff of 10.5 versus a loss of 9.5. The risk-reward ratio is obviously higher for put-based bear-spreads. This is illustrated in the Nifty bull & bear chart. |
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| A position of long 1640p (28) plus long 1650c (31.5) costs 59.5. This offers a profit only outside the range of 1580-1710. That's way beyond our expected range of movement. Can we construct wider straddles that offer better return-risk ratios? |
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| A long 1630p (23) plus long 1660c (26) costs 49 and offers returns outside almost exactly the same range. A long 1620p (20) and long 1670c (22) costs 42 and also covers the same range. |
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| An obvious arbitrage possibility is to sell the ctm position of short 1640p + short 1650c and buy the long 1620p+ long 1670c or the long 1630p+long 1660c. |
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| The wider position is illustrated in the chart Nifty arbitrage. The total payoff for the wider position versus the ctm offers profits across the range of 1630-1660 but it also has losses outside that range. |
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| The long 1630p+ long 1660c offers profits only if the market stays inside the 1640-1650 range but it never loses money. |
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My own inclination would be to go for the bear
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