Go for wider bull and bear-spreads

Trading interest is building up in the F&O market.

The surge in the past three sessions has really created an interesting situation for the derivatives trader. As it stands, the Nifty could move upto 2450 or down till 2350 next week and there are equally logical reasons to expect it to travel in either direction or to range trade between these two levels.

In the F&O market itself, there are signs that trading interest is building up. There was a significant increase in open interest across both futures and options segment despite the truncated trading period. The market PCR is at 0.73, which is neutral albeit lower than in the previous week. The Nifty PCR is almost unchanged at 0.91.

Index strategies
The Nifty futures are still trading at discounts although much less than before. Cash Nifty is at 2419 while the November future is at 2409, the December future is at 2400 and January is at 2392.

This level of backwardation is normal if we consider only Cash vs November and November vs December. The January future doesn't have the level of liquidity to present a trading opportunity.

A bearish calendar spread would eventually work if we sold November and bought December. But it has been our experience that this level of backwardation usually persists until the week before settlement so, we may as well wait before deploying this position.

A simple naked long November future is actually a fairly good gamble at this instant. If we do get a bounce till 2450 levels, even on an intra-day move, there would be profits in this. If there's an upside breakout past 2450, it could be highly profitable. The downside is easier to protect "� either reverse the position at 2370, or set up a bear-spread using options.

The options chain is still a little less liquid than one ideally desires, although there are quotes available across 2300-2500 in both puts and calls. However, prices could shift suddenly given the lack of OI in most positions and it makes it difficult to offer more than very general advice. But as things stand, there are imperfections which could work in favour of the smart trader.

A bull-spread with long 2430c (30) versus short 2450c (31) illustrates the problems! If these prices stand, the trader would be assured a minimum inflow of 1 with a potential maximum of 21.

But there is OI of only 1600 contracts at 2430 while the OI at 2450 is over 10 lakhs. One must assume that the 2430c premium will shoot up on Monday. How much is the question? If the differential between the 2430c and 2450c remains anywhere below 7, the bull-spread will still present a very decent risk:reward ratio.

A bear-spread of long 2400p (44.8) versus short 2380p (45) is similar! Here the 2400p premium is reasonable given an OI of 13 lakhs plus. But the 2380p has just 1800 OI "� this premium must reduce. Once again, if these prices stand, the bear-spread would be almost zero in terms of initial outflow and promise a maximum gain of 20.

If the differential of 2400p versus 2380p does not increase to more than about 7, the bear-spread still looks comfortable. If we take a long strangle with long 2450c and long 2400p, the position costs around 76. This could work only if the index moves outside 2325-2525. That's a big range and I wouldn't like to bet on it.

Wider bull-spreads and bear-spreads are possible and may in fact be the best strategy at this instant. A long 2450c (31) versus 2500c (17.8) costs 13 and offers a potential maximum return of 37. There's lot of liquidity at 2500c , so that price is also reasonable. A long 2400p (44.8) versus short 2350p (26.75) costs about 18 and pays a maximum of 32. Again a decent risk:reward ratio.

With the cash Nifty currently at 2419, it would take a 3-2.5 per cent movement either way by November 24 to extract the maximum from either of these positions. Given the historical volatility of the Nifty, especially in the past 10 months, the possibility of such a move occurring is quite high.

The bull-spread offers a better risk:reward ratio. so if you want a one-way position, go with the wide bull-spread. If you create both positions, in effect you hold a wide long strangle which is laid off by an even wider short strangle.

STOCK FUTURES/ OPTIONS

Most of the F&O stocks will move in tandem with the index. There are very few which appear capable of an independent bullish move and none appear to be under extraordinary bearish pressure. If one is looking for bullish defensive stocks, the best possibilities seem to be HDFC, ITC and Satyam.

In ITC and HDFC, there is plenty of futures liquidity and very little options liquidity. A long future in these two stocks would have fair chances of a payoff.

In Satyam, there is sufficient options liquidity to construct spread. There is also an apparent mispricing though there's ample OI. A long 620c (24) versus short 640c (13.6) costs about 11. With the cash price at 630, this is already very close to being in the money "� so there's less risk. The maximum payoff would be around 9. A long 640c (13.6) versus long 660c (7.6) costs 6 and pays a maximum of 14.

If you're seeking high-beta plays on the index, the three cement majors, ACC, Grasim and Gujarat Ambuja offer an interesting possibility. Each of these are likely to move with the index and all three are likely to be high-beta.

Perhaps GAC is likely to move the most distance "� it seems the most volatile. Depending on your index-view, you could take a position here instead. If you're bullish, buy GAC and sell the Nifty. Vice-versa if you're bearish. The GAC move will exceed the Nifty move while swinging in the same direction.