A calendar bear spread is attractive

Expect the market to stay bullish until derivatives settlement.

The major indices reached new heights this week although the trading and the bullishness was concentrated in a few F&O counters. There was enormous daily volatility and it would be reasonable to expect this to continue through next week with settlement due on Thursday.

There was an expansion in open interest (OI) as well as in implied volatility this week. We expect the market to stay bullish until settlement despite the intra-day correction on last Friday.

Index strategies
The spot Nifty is at 3573, the April Nifty is at 3583.9, the May Nifty is at 3576.8 and June Nifty is at 3571.75. OI has expanded across all three series and substantially so in the June series.

The premium on the April future versus May is normal at this stage and offers an opportunity of a calendar bear spread of long May and short April. By settlement, this premium should disappear.

In the options segment, OI has expanded and intra-day volatility has increased due to the short expiry time coupled to fairly high premiums.

The intra-day volatility increase is not surprising given that the market has generally been swinging through intra-day ranges of 2 per cent plus. The put-call ratio is at 1.4, which could be termed "normal"; it has climbed since last week when it was down to about 1.

The expiry factor adds an element of danger to any trades. Our technical perspective is that the Nifty has a projected upside of about 3670 though this could well be realized post-settlement. On the downside, a drop till support at 3520 is possible and a dip till 3550 is extremely likely.

A standard bull spread with long 3600c (37) versus short 3650c (17.25) is possible. It costs about 20 and pays a maximum of 30. A bull spread closer to money such as a long 3550c (64.5) versus a short 3600c (37) costs about 28 and pays a maximum of 22.

A standard bear spread with long 3550p (30.6) versus short 3500p (15) costs about 15 and pays a maximum of 35. A further from money spread such as long 3500p (15) versus short 3450p (7.25) costs about 8 and pays a maximum of 42. The bear spreads obviously have better return:risk ratios.

Normal spreads carry the expiry risk but reversed spreads are also dangerous here because the market is fairly volatile.

The furthest from money liquid call is the 3650c so that limits the possibility of creating reversed bear spreads since we have a technical perspective which suggests that this could be struck. Using puts, a reversed bear spread with short 3450p (7.25) versus long 3400p (4.7) pays only 2.5 and leaves a maximum liability of 47. That's a really adverse ratio of risk:return.

Straddles such as a long 3500p (15) and long 3600c (37) costs 52 and pays only if the market moves outside 3450-3650. That's pushing the envelope on our technical view as well. We could try to cut the odds by covering with a short 3650c (17) and short 3450p (7).

The resulting long-short strangle combination would cost about 28 and pay a maximum of about 22 if the market moved outside 2470-2630. This has an adverse risk:return ratio.

Perhaps the best option-based trade is a close-to-money bear spread despite our perspective that net gains are more likely. There's a fair chance that the long 3550p - short 3500p will be struck although it may not be fully realised.

The CNX IT index and the Bank Nifty both lack liquidity in the May and June series so calendar spreads are not a realistic option. Both April futures are trading at appreciable premium to the spot values. The April Bank Nifty is at 4624 while spot Bank Nifty is at 4596. The CNX IT April series is at 4467 while the spot is at 4463. Both are technically neutral or perhaps, tending to the bearish.

Selling the Bank Nifty appears to be a reasonable trade - that would gain if the index declined. You could hedge this with a combination of bank stock futures - if you did that, the resulting position would gain if the spot index and the futures converged in value.

STOCK FUTURES/ OPTIONS

As usual, most stocks have little liquidity in the options segment. In the futures segment however, there is a small list of stocks, which look fairly promising.

Despite the warning flag of the expiry situation, long futures positions are possible in HDFC Bank, Grasim, Tata Motors, MTNL and Tata Steel, where the trends seem distinctly bullish.

There are also arbitrages possible in situations where the futures are running at premiums. Inside the last four sessions of settlement, buying the spot and selling the futures could lock in a safe if small profit provided you reverse the trades at settlement.

This is possible in Tata Steel for example where the futures are priced at 661, while spot is at 654. The 1 per cent differential annualises into a nice profit over a 4-session timespan.

If you're feeling contrarian, long futures positions in BPCL or HPCL could pay off since both appear to have dropped to strong supports. But it would make more sense to take these in the next settlement, .since there's no guarantee of an instant rebound.

Another contrarian possibility is Satyam, where there has been a huge post-results drop to strong support. The Satyam April future is at 816 while the spot Satyam is at 810. You could buy a naked future betting on a technical bounce or, you can arbitrage with a short future-long spot position to lock in the 0.7 per cent differential.