Wide bear spreads seem the best strategy

DERIVATIVES

These are moderately priced and offer a good risk:return ratio.

The major indices hardly showed appreciable change through the week but there was a nervous undertone on Friday as global credit risks infected the UK and the FIIs sold heavily according to anecdotal evidence.

There is still two weeks to the settlement and ample liquidity. So, traders can certainly attempt to exploit any major moves that might arise.

Index strategies
The spot Nifty closed at 4518 while the September, October and November futures were settled at 4512.45, 4492.35 and 4478.6 respectively.

Other indices lacked liquidity in everything except the near-term September series. The Nifty Junior was at 8928.65 in spot and at 8949 in the September series. the CNX IT fell heavily and was held at 4641 in spot and 4645 in the futures. The Bank Nifty rose to 6912 while it was held at 6933 in the futures series.

The 20-point differential between the September and October Nifty could be exploited by a calendar bear spread that sells the September series and buys the October with an eye to reversing the spread very close to settlement as the two series align.

Among the other indices, the Nifty Junior spot could catch up to the future and the Bank Nifty may behave similarly. The CNX IT spot-future differences are negligible. There is no arbitrage available as such.

Technically, the CNX IT continues to look bearish while the Junior is bullish and the Bank Nifty indeterminate in its trading pattern. Since all positions are full-margin, any view you take will involve some risk.

The change in attitude of the FIIs on Thursday was interesting. They had been net buyers in the spot market earlier in the week but became net sellers on Thursday. While their overall derivative exposure expanded, it also became skewed.

They were far more interested in increasing long call exposures compared to short calls in the index options market. I am assuming this means a bit of hedging in anticipation of a period where they would sell a lot of spot holdings.

In terms of index option put-call ratios there was little change. The Nifty put-call ratio continued to hover around 1.5, which is bullish. However premiums didn't drop though the pricing was higher in puts compared to calls at the same distance from the money.

Technically the Nifty has been trading within a very narrow range of 4450-4550 with occasionally unsustainable spurts in either direction. The narrow range is not however, reflected in close-to-money options, which would normally become cheaper.

That means the market is expecting a lot of volatility accompanying a breakout within the settlement.

As and when this happens, we could expect a swing of about 100 points till the levels of Nifty 4650 on the upside or 4350 on the downside. Hence our critical range would have to be this 300-point zone between 4350-4650.

Even this wider range of expectation translates to less than 7 per cent in terms of current prices. Given that the Nifty regularly logs 2 per cent daily swings, and there are about 10 sessions left, it's hardly a great deal.

Normally one attempts to sell far-from-money options during a pattern of range-trading. There isn't a liquidity issue at this moment.

But the FII attitude is the incalculable factor. If there is a big pullout, the market could swing quite a bit more. If you're interested in selling uncovered short puts and short calls, it would probably not be safe to do so except with an additional margin of safety in terms of distance from the money.

In terms of normal spreads, a bull spread with a long 4550c (61.65) versus a short 4650c (21.35) costs 40 and pays a maximum of 60. A bear spread with long 4450p (61.35) versus short 4350p (36.1) costs about 25 and pays a maximum of 75.

Obviously the bear spread looks more attractive. However, it is significantly further from the money. In terms of probability, both spread could be struck but not fully realised, unless there is indeed a breakout.

Similarly a long strangle at long 4450p and long 4550c costs 122 and achieves breakeven if the market moves beyond 4325-4675. This is pushing the boundary of expectation. If you take a long strangle, cover with a short strangle such as a short 4300p (31.8) and a short 4700c (13.85).

That yields 45 in premium inflows, cuts the total costs of the position to about 77 and offers a potential maximum return of 70 on the downside and a potential maximum return of 70 on the upside.

It's very unlikely that both legs of this position will be struck however. On balance, the bear spread looks like the best possible strategy. It's moderately-priced and offers a good risk:return ratio.

STOCK FUTURES/ OPTIONS

In the stock F&O section, a number of counters are already at the position limit according to the NSE, which has banned the creation of fresh position the interesting dark horses would be Unitech and DLF.

Unitech has seen strong buying ever since its inclusion in the Nifty basket. DLF has also ridden due to the same enthusiasm.

Punters have also shown renewed interest in finance sector stocks. Twins HDFC and HDFC Bank have done well. So has Corporation Bank which has shot up.

But India Infoline may offer the best financial prospects for the trader who wants to be long. On the short side, the most interesting prospects come from the IT industry and perhaps, in cement.

Stocks like HCL Technologies and Rolta do not seem to have moved down to reliable support yet. Grasim was one of several listed cement companies, which saw a downward movement.