Watch out for calendar spreads

DERIVATIVES

One can go short January "� Long February in the hope that the two prices will align closer to the Jan settlement.

The technical perspective on the market is quite interesting. The Nifty is likely to oscillate for a while between the fairly wide range of 2880-2925. However there is a medium-term target of 3050, which should be should be achieved by mid-February.

With plenty of time to go before the January settlement on January 25, it's likely that we will see a movement beyond the 2925 level before the settlement comes through.

There is ample OI in the market and the market PCR is trading at 0.68, which is neutral. There has been some dip in the market OI which was earlier in the oversold zone.

Index strategies
The Nifty itself is trading at 2914 while the January Nifty Future is trading at 2895 with February Nifty future at 2887 and March Nifty Future trading at 2877.

There is actually a fair amount of OI even in the March future with over 64 K while there is ample liquidity in February and January in terms of OI.

The backwardation of the January Future with respect to spot is difficult to arbitrage without enormous resources. You would need to sell a Nifty basket on spot (which means either possessing delivery or arranging to borrow shares) coupled to a long position in the futures market. However we could take a naked long futures position in the expectation that it will catch up with spot.

The futures is close to the middle of the expected trading range whereas the spot is current closer to the top of the 2880-2925 range. A naked long future does carry the risk of a movement back towards the 2880 level.

The possibilities of calendar spreads are good. There is the standard possibility of short January "� Long February in the hope that the two prices will align closer to the Jan settlement.

There is also the possibility of a short February "� long March which would try to exploit the backwardation with respect to the March future. There is even the possibility of a naked long March future.

In the options market, a long 2930c (38.8) coupled to a short 2950c (32.5) offers a maximum return of 14 on an outlay of about 6. A standard bullspread is therefore reasonable "� the only reservation is the current pattern of range-trading because this spread would be in the money only in the event of a breakout.

A standard bearspread is more likely to be struck instantly since the Nifty is at the top end of the likely trading range. A long 2900p (59) versus a short 2850p (37.8) costs 22 and pays a maximum of 28. A less wide bearspread such as long 2900p versus short 2880p (50) costs 9 and pays a maximum of 11. There is very little OI between 2850-2900 however so these prices are not necessarily indicative.

Straddles and strangles are difficult to price because so many points on the option chain are less than liquid. It's also tough to recommend a strangle at say 2900 because the gross cost of 113 is so high. This position would only turn profitable if the market moved beyond 3015 on the upside or 2785 on the downside within January 25.

We can't lay it off that easily either so selling the strangle at 2900 would be difficult to assess in terms of risk and return. For what it's worth, a short 2900 strangle fetching a gross 113 could be laid off with a long 2850p and a long 2950c for a gross outlay of 72 and hence it would fetch a net 40.

This position would stay profitable only if the market stayed within 2860-2940. I don't think the likely return is worth the hassle of creating and monitoring this position.

STOCK FUTURES/ OPTIONS

There are scattered opportunities across the stock F&O universe. The banking sector seems to be going through some sort of positive re-rating.

HDFC Bank, Indian Overseas and UTI Bank are certainly likely to pay in terms of long futures positions. It may be worth getting into SBI and ICICI as well since it's unlikely that those two banking majors will stay out of the ambit of any major move.

Among other bullish stocks, Apollo Tyres, Bharat Forge, BPCL, BHEL, CMC, Gail, GE Shipping, HCL Tech, HDFC, Hero Honda, Hindalco, Indian Hotels, IPCL, Kochi Refineries and MTNL are all available in the F&O segment. Futures positions in any, or all of these stocks, is possible.

There seems to be little percentage in the options segment because of lack of liquidity in most of the counters that appear worth targeting. Liquidity should improve next week in most stock options as we come closer to settlement.