Opt for bull-spread

DERIVATIVES

The technical signals are in favour of a further decline.

After rising near its all time high and registering new closing records, the Nifty saw a sell off for 2-3 sessions.

The lack of changes in closing values over the past week has been deceptive because intra-day volatility has been quite high. Settlement may be quite volatile as well because there's an interesting combination of short-term weakness coupled to long-term bullishness.

Index Strategies
Open interest has grown overall in both the October and the November futures series. This is normal at this stage due to the rollover factor. The Nifty is trading at 3676 in the cash segment; it is at 3687.35 in the near-term futures instrument.

In the November settlement the Nifty was last settled at 3689. This is highly unusual "� the November series is already at a premium to October series whereas it has usually trended at a discount at this stage of settlement.

Of course, the premium is nominal and not worth trying to arbitrage. But is this trend likely to continue before Thursday?

Normally the process of rollover leads to volumes going into the mid-term future and thus pulls it up from a discount. If this happens, November will trade at a substantial premium and we should take a bear-spread with short October, long November intending to settle on Thursday.

On the other hand, if the market does break and dip, it's very likely that the November future will go into discount again by Thursday.

In that case, a long October, short November position works. Which way should the trader go? I'd incline to the long October, short November position because the technical signals are in favour of a further decline.

The situation in the CNXIT and the BankNifty are also interesting. The Banknifty closed at 5333 on Friday while the October series was held at 5346 and November at 5354.

There is enough OI to make November tradeable though liquidity isn't high in that series yet. I'd stay with a short October, long November recommendation because bank stocks do look a little weak and there is a tendency for the mid-term series to accelerate to a substantial premium in the last two sessions of settlement/ rollover.

The other option is a naked short October "� the differential between the spot price and the near-term must narrow down to zero by Thursday. This is a high margin position unlike the calendar spreads.

In the CNXIT, spot prices are at 4880, while October is at 4890 and November at 4912. Again liquidity is thin in the November contract but it is tradeable.

Here a short-October long November would be geared to the view that the premium on the mid-term would widen substantially but there's already a significant gap. I'd be more inclined to a long October, short November position, which gains if the differentials between the two series drop.

A naked short October could work "� but the differential with the spot isn't much and it is a high margin position.

In the options market, our view is that the Nifty could drop till the 3625 level at least. However intra-day volatility has risen and a sudden jump in intra-day prices cannot be ruled out either.

On the upside, we'd say the resistance at 3725 is unlikely to be exceeded in this settlement.

If we're examining October Nifty options, the position still remains net oversold with the put:call ratio at about 1.34.

In the November Nifty options section, Open Interest is much less but the Nifty put:call ratio is at a highly oversold value of 2-plus. Taken in conjunction, these OIs suggest that there will be at least one session of strong gains.

In the October series, a bullspread with long 3700c (24.65) and short 3750c (9.35) costs 16 and pays a maximum of 34. A bearspread with long 3650p (14.95) and short 3600p (6.5) costs 8.5 and offers an amazing 41.5. The main problem is expiry risk which is why these options are at such low premiums. Of course, if you decide to take an October position, I would prefer the bearspread because it has better risk:reward ratios.

In the November series, a bullspread with long 3700c (105.55) versus short 3750c (77.45) costs 28 and pays a maximum of 22. This is an adverse risk:reward ratio. A November bearspread with long 3650p (101.1) and short 3600p (83.6) costs 18 and pays a maximum of 32.

That's actually a decent risk:reward ratio and there is no expiry risk. So I'd say that the November bearspread is on balance, the most worthwhile of the common spreads available on the Nifty.

It has decent ratios, good liquidity and a long way to run till expiry. If you don't mind a "slog over" situation, you could try the October bearspread as well hoping that it's struck before expiry.

STOCK FUTURES/ OPTIONS

Tata Steel is obviously the flavour of the day with a large buildup in OI in the past three sessions. The price hasn't changed much. The November contract has plenty of liquidity so go long in the November contract if you decide to get into this counter.

GMR Infrastructure could be a dark horse. The Newly-listed infrastructure company has generated large volumes and it's been moving up. Unfortunately the October future has far more volumes than the November series so you could be raking expiry risk.

On the short side, auto stocks like Maruti, Bajaj and Hero Honda look quite weak and may be worth a short October future. Unfortunately, there are no obvious arbitrages available between spot and October future or between the October-November series'.