Long March, short April

A recovery in the Nifty's trend, even temporary, would cause the March contract to rise relative to April.

The settlement came amidst turmoil and high volatility. The switchover took place under bearish conditions, which became worse on Friday when the direction was uniformly south. There may be a dramatic reversal next week if the Budget is well-received. This is a key settlement "� it sandwiches the Budget and runs for five weeks.

Index Strategies
The Nifty closed at 3938 in the spot market after a 5 per cent slide. The March Nifty future was held at 3933.75 "� there was enormous volume and open interest expansion. The April Nifty future was at 3939.45 but with relatively low open interest.

There is likely to be massive volatility through next week followed by a trending movement after the Budget. Which direction, we don't know. In practice, the first couple of post-Budget trading sessions define direction except if there is some unexpected political setback.

In the Nifty futures segment, the best shot seems a calendar bull-spread with a long March future versus short April future. A recovery in the Nifty's trend, even temporary, would cause the March contract to rise relative to April.

The CNX IT was held at 5544.55 in the March futures segment while the spot CNX IT was at 5527.5. The Bank Nifty March future was at 5499.65 while the spot Bank Nifty closed at 5473.6.

Technically and fundamentally, the bank sector appears to be under pressure so, it may make sense to short the future. If the Budget is well-received, this could reverse but only temporarily, given the rise in interest rates, the CRR hike and yield inversions in bond markets.

The CNX IT is in better shape technically although it was also bearish. Fundamentally, the industry is doing well and the rupee weakening this week is good for IT.

However the risk is that it would crash if a tax on export earnings is imposed. Perhaps, it makes sense to stay out of the index and only focus on specific IT stocks.

In the Nifty options segment, the March put-call ratio is 1.5. It was up to 1.9 a few sessions before settlement whereas the February put-call ratio was down to 0.9.

A put-call ratio reading of above 1.5 should be bullish. The derivative outstandings of FIIs suggests that a substantial portion of this open interest is composed of long puts, which are likely to be hedges.

Our technical perspective is that the Nifty may swing anywhere between 3850-4150 without establishing pre-Budget direction. It should break one of these two support/resistance levels after Wednesday. That means a minimal downside of almost 100 points coupled to a likely upside of 200-odd points, all on intra-day basis.

In that context, option premiums are probably slightly low given likely volatility. There is asymmetry in option prices "� puts are more expensive than calls at the moment, reflecting the bearish sentiment.

If you're looking to exploit wide swings, you will probably want to take a strangle with say, long 4200c (36.8) and a long 3800p (82.5) and wait for post-Budget developments.

This position costs a whopping 120 and it cannot be laid off due to lack of liquidity beyond these levels. So it would work only if the index moved beyond 3680-4320. This is not outside the bounds of possibility but it is a stretch.

A standard bull spread with long 3950c (105) versus a short 4100c (65.85) costs about 40 and pays a maximum of 60. A standard bear spread with long 3900p (124) versus short 3800p (82.5) costs about 42 and pays 58. Both these positions could be hit and full realised if the expected levels of volatility occur. The bull spreads have marginally better ratios.

So if you want to exploit a big swing in either direction, the sensible thing is to take a bull spread and couple that to a short March future.

This is a high margin exposure but it would profit from a big move. You would have to exit the future with a stop loss if the market lifts beyond 3975 or so.

Better still, take the option bull spread on Monday and wait until Wednesday evening before deciding on the short future. If the market breaks, you'll get four weeks to exploit it.

STOCK FUTURES/ OPTIONS

There could be rich pickings in the stock derivatives segment if you are on the right side of the trend. Individual stocks are likely to swing more wildly than the Nifty. Budget-related movements are usually sector-specific so they are relatively easier to target.

Let's list the usual suspects in sectors. IT looks strong and failing a tax on exports, quite likely to be untouched by the Budget. This would be my favourite area for long positions - Infosys, Wipro and Mphasis would all be ideal, the latter due to its astonishing strength in a falling market.

The cement sector has seen massive sell-off as a fall-out from the dip in construction and real estate stocks. ACC and Grasim have both hit the skids. ACC could be a decent short.

The auto sector is likely to be quite sensitive since excise cuts are expected. It has fallen quite sharply. If there's a bounce-back, the best choices may be Maruti and Bajaj. Long positions here may be suitable.

Reliance is an island of strength in the refining exploration sector and worth a long position. The PSUs have all been hit hard and look unlikely to make full recoveries. Banks present an unusual case. The Budget is unlikely to make much difference, failing a hike in FII limits which is politically unlikely.

However these stocks could lift on overall sentiment alone. Housing finance is more clear-cut. If the government hands out sops in the sense of a larger tax breaks for mortgaged house buyers, HDFC and LIC Housing will both jump.