Take a bear-spread

Volatility is likely to stay high until settlement.

Two sessions of gains have somewhat altered the dynamics of the derivatives market. There's still two weeks to go for the derivatives settlement and there are now more players betting on the possibility of an uptrend. Open interest (OI) has risen across the futures and options segment.

Index strategies
The Nifty is now trading at 2890 and our technical view would be that it could rise till around the 3100 level or even 3150 before the next major retracement.

On the downside, there's support at 2850 and below that, at 2775. Volatility is likely to stay high until settlement "� expect swings of at least 3 per cent per day (defined as high-low range over close).

The June Nifty future is trading at 2881 while July is at 2859 and August is at 2840. Open interest has risen in all three segments but August is still comparatively low at 58000-od contracts.

The discount of the July series versus June is still fairly large. This makes it possible to take a bear-spread with short June- long July. This will gain if the spread converges by settlement as it should.

Among the other two tradeable indices, the July and August series are short of liquidity. The June BankNifty is trading at 3729.6 with the spot index at a value of 3770. The June CNX IT is trading at 3595 with the spot held at 3628. The differential between the BankNifty spot and future is substantial, the differential between the CNXIT spot and future less so.

However the technical position suggests that the CNXITm is more likely to move up given that more IT majors are looking bullish in comparison to the banking sector. It would be reasonable to take a long position in both futures but these can't be hedged so the risks are high.

In the options market, the Nifty premiums continue to display high implied volatility. This is likely given that current volatility is extremely high. The put-call ratio has risen from extremely overbought levels of just about 0.5 to mildly overbought levels of 0.7.

This is because OI spurted strongly in the Nifty puts segment last week while OI in calls declined marginally. One would assumes that the large increase in put OI is due to hedging.

The relatively low PCR is still a danger signal. During the previous bull-run, the PCR rarely fell below 1. Conventional wisdom is that the PCR is driven by events in the spot markets.

However, given the huge volumes in the F&O market, it could easily work the other way around. That is, the overhang of extra calls may form a barrier to prices rising. There is massive call clustered at strike prices between 3100-3250.

As for standard options positions, a conventional bullspread with say, a long 2950c (74) versus short 3050c (43) costs 31 and pays a maximum of 69.

A conventional bearspread with long 2850p (91.5) versus short 2750p (61.5) costs 30 and pays a maximum of 70. Both positions have excellent risk:reward ratios and both carry a high probability of being fully realised before the settlement.

It's possible to take less wide spreads such as long 3050c versus short 3100c or long 2800p versus short 2750p. These also have excellent risk:return ratios and the initial outlay is less.

However, the "long leg" of the trade should be fairly far from money. In a market of excessive volatility, there's always a tendency for close-to-money options being relatively overpriced.

If you're willing to take somewhat greater risks, strangles far from money are also quite attractive. A wide strangle with long 3000c (61.65) and long 2800p (75) costs about 137. This can be laid off with a short 2700p (41.75) and a short 3100c (30.75).

The net position would cost about 65 and be profitable if either side of the transaction is fully realised by a Nifty move to either 2700 or 3100. If both sides are realised, there would be nothing like it.

While the reward:risk ratios on strangles are not as good as with the bullspreads or bearspreads, the strangles are attractive because they would leave a trader covered against moves in either direction. All you need is volatility and that should be a given.

STOCK FUTURES/ OPTIONS

Most stocks appear to be almost completely in line with the Sensex/ Nifty in terms of directional movement. Very few look likely to outperform the index in either direction.

From the trader's point of view, this means you can find a high-beta stock (or a high-beta stock basket) to get an exaggerated version of market return. But you cannot easily find a stock that will offer protection against an adverse market move.

There's a very short list of stocks that could outperform the market during the next two weeks in that they look individually bullish. This list comprises Bajaj Auto, Bharti Airtel, Bharat Forge, HDFC Bank, Satyam, Sterlite, TCS and Tata Steel. As always, there's far more liquidity available in the futures segment than in options.

It's possible to go long in this set of stocks in the June futures segment. In all these, the futures prices are discounts to the spot.

In Bharat Forge, where spot is at 334, with June futures at 326, this may be worth an arbitrage of selling the spot and buying the future. Bajaj also presents a tempting arb "� with spot at 2648 and June future at 2595. If you hold the stock, sell and buy the future.