A report on the trading and arbitrage patterns seen in the options market during the past week
Through the whole of last week, the near-month Nifty future traded at a discount to the cash price whereas the Sensex demonstrated a fair degree of efficiency. All the futures contracts of the Sensex had been traded at a premium to the cash market. This could be because of the fact that it is easier to trade in 30 shares rather than 50 at a time. The Sensex comprises of 30 shares and the Nifty, of 50 shares.
The options market still has a long way to go in achieving complete efficiency. A number of series have thrown up excellent arbitrage opportunities. The number is much higher when it comes to short positions in shares and put options and long positions in call options, which is equivalent to short selling. The Tata Tea, Aug 01, Rs 160 series offered an arbitrage opportunity that promised an annualised return of 57 per cent. The underlying closed on Friday at Rs 159.50. The respective calls and puts were traded at Rs 3 and Rs 2.
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We recommend keeping an eye on the same series on Monday. Though the series gave very high returns on Friday, there is a possibility that one of the contracts may not be traded at all on Monday. Because the put and call option contracts were being traded at premiums that were quite close to their break-even, the premiums were very low. Premiums of contracts can be very sensitive to fluctuations inthe price of the underlying. If the share price moves up by Rs 3.50, the call option will enter into positive pay-off territory. Similarly if the price goes down by Rs 1.50, the payoff for the put option will turn positive.
If the price of the underlying remains below Rs 160 and puts are traded at a premium of below Rs 2.50, one can use the arbitrage opportunity by simultaneously selling a call option at a premium of above Rs 2.80.
Similar arbitrage opportunities were seen in the Larsen & Toubro, August 01, Rs 220 series. The underlying closed on Friday at Rs 214.20. The put and call options were traded at premiums of Rs 2 and Rs 6 respectively. An arbitrage position of long in the underlying and put and short in the call could earn a return of around 49 per cent per annum.
The put option of the series was traded at just 20 paise away from a positive payoff. That means if the price of the underlying share goes down by Rs 0.20, the payoff of the put option will turn positive. But if the same should go up by Rs 7.80, they will bring the call options into positive payoff territory. Here, the put option is more sensitive to the fluctuations in prices of the underlying. We again recommend keeping an eye on the series. If the underlying is traded at below Rs 214.50 and put options are traded at a premium of below Rs 6.50, one can fetch a handsome return by simultaneously selling a call at premium above Rs 1.50. At that premium, the call option will be only Rs 7 from the break even.
Because of the lack of a proper stock lending system, there were at least 17 series that handed a reverse kind of arbitrage opportunities with annualised return more than 20 per cent. The arbitrage required a position of going short in underlying and a put option and long in the call option, which is equivalent to lending shares with an assured return.
Last week we asked our readers to watch out for several series. One was the HPCL, 30/08/01, Rs 130. We said that a long position in the underlying stock at below Rs 131 and the put option at below Rs 6 and short in call at above Rs 8 would give an arbitrage opportunity. On Monday, the put and call option contract opened with respective premiums of Rs 6 and Rs 8 - in line with our recommendation. Against this, the stock opened at Rs 135.10 on the National Stock Exchange (NSE), nullifying any profitable arbitrage opportunity. But the same stock opened on the Bombay Stock Exchange (BSE) at Rs 129.70. That matched our recommendation and required a cross-exchange arbitrage position to book an annualised return of around 65 per cent.
In the process of correcting the mispricing in the NSE, the HPCL series went a step further giving rise to a reverse kind of arbitrage opportunity that was equivalent to lending shares.
The same was the case with the Tata Tea, 30/08/01, Rs 150 series. The underlying opened at Rs 169 at the NSE and at Rs 157.50 at the BSE. The respective call and put option contracts opened at Rs 15 and Rs 4. We suggested a position of long in the underlying at below Rs 159 and put at below Rs 5 and short in call at below Rs 15. While the stock price at BSE gave a pure arbitrage opportunity, with the NSE price of the series gave rise to a reverse kind of arbitrage opportunity. A long position in the underlying at the opening price on the BSE and put option on the NSE and short in the call option on the NSE would give an annualised return of 86 per cent.
For the Digital Equiment, 30/08/01, Rs 440 series, the put option was not traded at all on Monday.