Stay close to the money

DERIVATIVES

The market goes into settlement week in buoyant conditions. Volumes and Open Interest is high and liquidity is already apparent in the July series. Implied volatility is high and actual volatility is likely to increase.

Index strategies
The Nifty closed at 4252 in spot with the June futures held at 4240.75 and the July Nifty futures held at 4232.75.

The Bank Nifty rose by nearly 6 per cent and closed at 6542 in spot with the June future at 6550.65 and the July future at 6556.40. The Junior was at 8429 in spot and at 8411.40 in the June futures. It was illiquid in the July series as was the CNX100 which closed at 4173 in spot and settled at 4158.85 in the June series.

The CNX IT was the only party pooper losing to close at 5160 while trading at 5174.70 in the June series and at 5228.35 in July. It's noteworthy that both the BankNifty and the CNXIT have developed some OI in the July series because that's unusual even at this stage of settlement.

There is substantial OI across a range of instruments not just index futures and options. It's noteworthy that the spot Nifty is trading at premium to the June series and June at premium to July. We can generate a calendar spread here with long July- short June but the basis is very small.

Similarly, the basis difference between calendar contracts is extremely small in every index except the CNXIT. Here a calendar bullspread may make sense with a long June, short July position. With a 55-point differential, the forced convergence at settlement should yield good returns.

In the Nifty options market, the key range is around 4175-4325 with the chance of high intra-day volatility and range-trading. The Nifty put-call ratio for June is at 1.25, down a little from Thursday but still in a bullish range.

The Nifty PCR for July options is very high at 2.08 given that there is plenty of liquidity. While OI came down slightly in June puts, it rose sharply in June calls, and in both July puts and calls. This is an obvious signal that a large carryover is already progressing.

My view is that, given the likelihood of range-trading stay close to money in the June options series. If you're looking for a breakout, consider wide straddles and strangles in the July series. As a matter of fact, with the June future at 4240 and the cash Nifty close at 4252, the 4250 point is practically in""the-money for calls and its in-the-money for puts.

A Bullspread with long 4250c (36.5) and short 4300c (15.6) cost about 20 and pay a maximum of 30.

A Bearspread with long 4250p (44.25) and short 4200p (24.65) costs about 20 and also pays a maximum of 30. The risk-reward ratios are pretty much the same and the contracts are almost bound to be struck. If we're right in our volatility expectations, both spreads could be struck and fully realised beforeexpiry.

A straddle at 4250 with June options costs about 80, so this is stretching to the limits of our expected range-trading zone. This is possible. One should also consider the two spreads taken together which is of course, a long straddle.covered with a short strangle. This position costs about 40 and pays maybe 60.

In the July series, one could consider the 4300c (86) versus short 4350c (64) bullspread. This costs 23 and pays a maximum of 27. The July bearspread of long 4200p (110) and short 4100p (75) costs about 35 and pays a maximum of 65. Nice risk:reward ratios but the initial cost and margin is high. On reflection, July strangles cost too much.

A long 4100p and long 4300c will cost 160 and breakeven only outside 3940-4460. July would need to be a massive swing month.

There is a chance that the market will swing quite a bit in July. It has been generating high OI and high spot volumes at prices very close to the historic high.

However it has not been able to break out. The downside support has also seen a lot of testing. One suspects that immediately post-settlement, there could be a breakout and that could occur in either direction.

STOCK FUTURES/ OPTIONS

The stock futures market has seen massive OI developing across the bank sector where SBI and ICICI are not the only interesting stocks.

Bank of India looks good. A darkhorse could be Educomp, which has seen bulk deals in the past few sessions and is one of the counters generating massive interest.

There's an apparent arbitrage available here with the spot at 2310 and the future settled at 2322.35. That will be picked up early on Monday probably with the stock rising while the future consolidates.

HLL is also looking interesting. A short position seems to be dissolving and this is now worth a long position. Dr Reddys, Divis lab and Aurobindo all look bullish but the latter has had a lot of profit-booking already.

Most interesting technically is Reliance Energy. The stock has shot up in the last five sessions and so has the future. But there has been almost no differential between the two series.

Usually differentials between spot and future are picked up and arbitraged quickly but a little difference exists. REL is worth going long without any fear of "settlement interference".