The market is bullish

DERIVATIVES

Most F&O stocks trading with the same velocity and direction as the Nifty

The market firmed up at settlement and Friday saw a surge in values across the board. Although the long-term direction of the market is still uncertain, it's clear that an intermediate uptrend started in mid-June. The new settlement has been ushered in with excellent liquidity.

Index Strategies

The Nifty closed at 3128 on Friday. The July Nifty future was held at 3118 while the August Nifty future was at 3100. There isn't much liquidity in the September series yet "� that's normal early in a settlement. The OI is up substantially in the July and August series. The technical perspective is that the market is bullish and very likely to rise until 3250.

On the downside, there's support at about 3000. Given the bullish scenario, the discount on the futures versus spot makes a long July Nifty very tempting. Though it's early in the settlement, the differential between July and August is also substantial so it's also possible to try and sell July and buy August in a calendar bear-spread.

In the other two tradeable indices, the July CNXIT is trading at 3943 with barely acceptable levels of liquidity while the spot CNXIT is at 3957.55.

The July BankNifty is trading at 3694 while the spot BankNifty is at 3709. The BankNifty future is at an enormous discount, the CNXIT future less so.

Both indices seem to offer reasonable long futures positions. But the risk will be substantial this early in the settlement since these will be unhedged positions. The differential should narrow close to settlement (June 27) and of course, it would disappear on settlement itself. But a drop in spot values would be reflected by similar drops in the future.

In the options market, there has been an important change in the trend of background indicators. Apart from an overall, almost evenly-distributed expansion in OI ( there are more new open calls than puts), the put-call ratio for the July Nifty has climbed above the 1 mark. This is bull-market behaviour and it's in clear contrast to the pattern since mid-May when the PCR was consistently held below 1.

As such, a high PCR is generally taken to indicate an oversold market though this may underestimate the effect of hedging of long positions in the spot market.

In practice, a high PCR usually does mean that the spot market continues to rise. Since this indicator is backed by bullish spot-market signals at the moment, it reinforces our belief that prices will rise further.

When we look at close-to-money premium chain and the resulting spreads, we discover that puts are now more expensive than calls "� another asymmetry that usually arises in a bullish market.

A bullspread with long 3150c (100) versus short 3200c (78) costs 22 and pays a maximum of 28. A bearspread with long 3100p (113) versus short 3050p (94) costs 18 and pays a maximum of 32.

The risk:reward ratios are good for both these positions but clearly the bearspread offers a better return. It's very likely that both these positions will be struck within the settlement since they are within 3 per cent of the spot and the Nifty has been fluctuating an average of 2.25-3 per cent per session.

If you're looking for straddles however, it makes more sense to seek wide positions since that cuts down on initial premium. We could think of a long 3250c (58) and long 3000p (76). That costs about 134 and turns profitable only outside 2870-3390. If we lay it off with a short 3300c (42) and short 2950p (63), the net premium payout drops to 29.

This combination long-short straddle would return a maximum profit of 21 if the market trades out to either 2950 or 3300. If both trades are struck, the ratio of return:risk will be a maximum profit of 42 versus an initial payout of 29. This is worth it in my opinion because both sides of this straddle could well be struck before settlement.

Stock F&Os

Most F&O stocks are trading with the same velocity and direction as the Nifty, that is, at betas close to 1. The bullishness has been quite broad, which makes it impossible for us to safely find any short stock F&O positions.

Also arbitrage positions are simply not worth it this early in the settlement. There's a very short list of bullish stocks, which might outrun the Nifty and/or keep rising even if the Nifty changes direction. Of that list, even fewer offer sufficient liquidity to even contemplate an options position. All have ample futures liquidity however.

The list of likely high-beta stocks includes BHEL, Gujarat Ambuja Cement, HDFC Bank, Hindustan Lever, Mahindra, Reliance Industries, Tata Motors and Wipro. We could take long futures in these underlyings with some confidence.

In the options market, Reliance and HLL possess the highest levels of liquidity among our list. And, even HLL possesses very liquidity in comparison to its size. Reliance is trading at around 1060 in spot and a long 1060c (41) versus a short 1110c (21) costs about 20 and pays a maximum of 29.

In HLL, the spot is at 229 and a long 230c (10.3) versus a short 250c (3) would cost about 7 and pay a maximum of 13. As mentioned above, liquidity is quite low in the HLL options series. So the HLL premiums may not be fully indicative.