Watch the spreads

DERIVATIVES

Close-to-money bullspreads present better risk-return ratios than CTM bearspreads. Taking far-from-money spreads in either direction could pay off well.

The sell off on the last two sessions of the week leaves an intriguing situation. In the short run, the Nifty appears almost certain to lose more ground.

However both the long-term and intermediate trends seem to be positive and there's still two weeks to go for settlement. We need to monitor support levels carefully to diagnose an intermediate trend reversal as early as possible.

Index strategies
The spot Nifty closed at 3650 on Friday with the May future at 3633, June at 3621 and July at 3615. All three futures series have excellent liquidity with plenty of open interest even in the far series. The differentials are noticeable.

It is possible to take either of two calendar spreads to try and exploit the differentials. If we sell May and buy June, we could reverse the trade close to settlement (May 25). This would work if the 12-point differential became less. If we sell June and buy July, the trade is similar but the differential isn't much. We could also try to buy July and sell May "� again this trade works if the differential drops.

Our technical perspective for the week is that the Nifty is likely to fall till somewhere between 3575-3600 before it finds reliable support.

On the upside, there's significant resistance at above 3700 but the Nifty is likely to get to 3700 levels in intraday trades at least. A close below 3575 would suggest that the intermediate trend has changed. Expect the intra-day high-low range to be around 70-80 on normal sessions. This gives us ample scope to take spreads in both directions.

There have been interesting developments in the options market. A large number of puts were cashed out in the past two sessions while an even larger number of new calls were bought. Hence the put-call ratio has declined to around 1.31, which is close to being overbought in the context of this market.

In the options segment, a bullspread with long 3650c (75) versus short 3700c (55) costs 20 and offers a maximum return of 30. That's a reasonable ratio. A wider bullspread with a short 3750c (39) as one leg is also possible.

This would cost either 36 (if we took it with a long 3650c) or 16 (taken with a long 3700c) and offer a maximum return of either 64 or 34. It could be a reasonable position to take given that 3750 is likely to be reached in intra-day movements before settlement.

A bearspread with long 3650p (84) versus short 3600p (56) costs 28 and offers a maximum return of 22. A wider bearspread with long 3600p (56) versus short 3550p (45) offers a much better risk to return ratio since the position costs only 11 and pays a maximum of 39.

There is a chance that this position could be fully realised and the spread would certainly be profitable if the Nifty fell to even the top of the 3550-3600 band, since the put premiums would appreciate.

Our perspective would thus be that close-to-money bullspread present better risk:return ratios than CTM bearspreads. Taking far from money spreads in either direction is a calculated risk but there is a good chance that it could pay off and the risk:reward ratios are quite excellent for the FFM spreads.

Of the other two tradeable indices in the F&O segment, the May Banknifty is at 4887 with the spot Bank Nifty at 4871. The CNXIT May series is at 4392 while the CNXIT spot is at 4406.

Unfortunately there isn't enough liquidity in the June or July segment to set up trades. The Banknifty appears bearish "� the future is worth selling given the fact that it's running at a premium. This is an unhedged trade and hence, quite risky.

The CNX IT appears to be running flat and the future may be worth buying given that it's at a discount to the spot. Again this would be a risky unhedged trade.

STOCK FUTURES/ OPTIONS

There are more tempting short positions available in the stock F&O section than long positions. About the only underlying stock where one would confidently go long is Dabur. Hindalco has some potential and so does NTPC. Maruti has also apparently bottomed out but it's an open question whether the stock will move up much inside this settlement.

On the short side, any cement stock, which is available in the F&O segment is probably worth a short at the moment. The dimensions of price control are not yet clear but unless the news was much exaggerated, there could easily be another 5 per cent fall across the cement sector.

Several bug bank stocks have also started falling "� that is why the Banknifty is looking bearish. Bank of Baroda, Bank of India and Canara Bank all seem like safe short futures positions.

Reliance Industries has also seen some big-ticket selling in the past couple of sessions. The spot is at 1066, the May RIL future is at 1076 and the nearest reliable support is at 1000. Go short. There is sufficient liquidity to use options in RIL so you could construct a bearspread with long 1060p (28) versus short 1040p (19) to create a position with a marginally favourable risk:reward ratio. If you decide to push the envelope, take a long 1060p (28) versus short 1000p (6) "� the position costs 22 and pays a maximum of 38.

RPL is too newly listed for us to be able to make much sense of the trend. It seems however as though a lot of people are intent on booking profits on their allotments. The stock is likely to fall till around 75 (about 10 per cent above issue price) before it stabilises if this is the case. So you could cross your fingers and go short.