Vanilla bearspreads preferable

DERIVATIVES

Sometime during the settlement, market is almost certain to retrace till 3500, which would mean full realisation of the 3500-3550 bearspread.

The rollover went quite smoothly with the market displaying a small upwards bias. The FIIs were major participants in this process "� they bought quite heavily in the cash market last week and their F&O exposure increased in commensurate fashion. However breadth is weak and momentum indicators suggest a slowdown.

Index strategies
The market has run into major resistance at 3600, which it has been unable to penetrate.

Cash market volatility has been rather low and implied volatility is also low if we adjust for the effect of a new settlement where liquidity is still developing. Open interest has expanded quite satisfactorily however in the October segment.

The technical perspective on the Nifty would be that, even if 3600 is penetrated, the market will probably top out by 3650.

Given the time-factor, we could expect an intermediate downtrend to start within the October settlement and that downturn may even pull the market back till the 3325 level before it ends. As and when the trend reversal starts, volatility will spike.

The cash Nifty itself is trading at 3588 with the October Nifty future held at 3588 while November is trading at 3587. The lack of differential is unusual.

A calendar bullspread of long October and short November contracts would work if the differentials increase "� we could normally expect the November contract to trade at a discount of some 10-15 points or even more if the market does break.

In the options segment, the Nifty put-call ratio is still high at 1.48 - this is one signal that suggests the market could break the 3600 resistance and continue to run up for a while.

However the PCR has reduced from its pre-settlement levels of 1.6 so, the options market is not as oversold as it was. And there are anomalies if we consider the close to money situation where the PCR is not really that oversold.

A standard options bullspread of long 3600c (79.25) versus short 3650c (50.85) costs a net of 30 and offers a maximum return of 20. That's an adverse risk:reward ratio, which is puzzling in the middle of an uptrend.

It reinforces my feeling that we're heading for a likely reversal of the intermediate trend "� this sort of adverse ratio generally shows up only when there is a reversal in the offing. A further from money bullspread is not possible because quotes on the option chain peter out above 3670.

If we consider bearspreads, the long 3550p (72.6) versus short 3500p (55) costs 17 and offers a maximum return of 33. That's a much better ratio than the bullspread and in a volatile market, the bearspread may be preferable.

Taking strangles is difficult and expensive because of the lack of liquidity above 3650. An open strangle of long 3600c and long 3550p costs about 155. This will only work if the market swings outside 3400-3760. That's too wide a range for comfort. We could hedge on the put with a short 3450p (42) but it's an unwieldy position.

Given the situation, I would suggest that vanilla bearspreads are more likely to work than anything else. Sometime during the settlement, the market is almost certain to retrace till the 3500-level, which would mean a full realisation of the 3500-3550 bearspread.

In the CNX IT futures, there's lack of adequate liquidity and the technical indicators suggest that the IT sector is not likely to offer a strongly trending pattern in the next week at least.

It dropped last week even though the broader indices went up. The CNXIT October futureis at 4554.55 with the spot at 4540. If you want a position here, stay short "� that will gain if the differential reduces or the spot market comes down.

The Banknifty presents a more intriguing situation. The index jumped over 6 per cent last week despite a sharp sell off on Friday.

The spot Banknifty is at 5276 while the October is at 5286.5. Will the sell off continue or will bank shares surge again next week? I haven't a clue about the very short term but in the perspective of the next 3-4 weeks, net gains are extremely likely.

The Bank indices have hit all-time highs and the sell off appears to be a small correction in that context. Stay long if you can bear the high margins of unhedged positions in what's likely to be a very volatile sector.

STOCK FUTURES/ OPTIONS

Attention is likely to remain focused on bank and financial sector stocks if the past week is any guide.

There's a huge list of highly capitalised banks in the F&O segment. They are all likely to move in unison whatever the direction "� I think the initial move may be profit-taking followed by further gains.

My suggestion would be to pick a basket of the 3-4 most representative "� SBI, ICICI, HDFC and HDFC Bank could do the trick - and trade this. If you can bear the margins and volatility, stay long.

HDFC is not part of the Banknifty "� it offers exposure to the housing finance sector. SBI incidentally offers a possible arbitrage "� the stock is at 1024 while the future is at 1036. Sell the future and buy the stock.

Among other stocks, auto shares could be winners as well. Bajaj, Maruti and Mahindra offer exposure to most segments of the market and each stock looks individually bullish.

GE Shipping and NDTV are also possible long positions. On the short side, BPCL, HPCL and Gail look like shorts.