Arbitrage opportunities in stock futures

DERIVATIVES

The discount to spot is marked across the entire index futures segment.

While the July settlement went off smoothly with record volumes in excess of Rs 1,00,000 crore-plus, the crash on Friday has left the market in turmoil. There was over Rs 65,000 crore of trading on Friday with a high generation of Open Interest (OI).

Index Strategies
There was a fair amount of carryover and the current OI situation makes it likely that much of that volume remains in the market. The Nifty closed at 4,445 in spot with the August series settled at 4402.2 and September at 4,390.35.

The Junior was held at 8,722 in spot with August settled at 8,648.9 and September at 8,836. The CNX IT was at 5,091 in spot and at 5,061 in spot. The BankNifty was at 7,086.5 in spot and at 6,719.25 in the August series.

Apart from the Nifty, the other index futures did not see too much liquidity generated in September series. The BankNifty was the only index that saw a drop in OI as many traders closed out positions after a huge drop. All other indices saw healthy OI expansion in the August series.

Obviously, the discount to spot is marked across the entire index futures segment. Theoretically the difference should bring in arbitrageurs who sell Nifty stocks on spot and go long on the index. This is cumbersome but there may be enough big players in the market to make it possible.

In itself, the differences make long futures positions tempting because the differentials are likely to get narrower regardless of market direction. However massive discounts to spot also suggest that expectations remain bearish. There isn't enough differential in the August-September Nifty contracts to make calendar spreads worthwhile.

In the index options market, there is not enough liquidity in anything except the Nifty segment. There OI has expanded across both puts and calls and the August put-call ratio (in terms of OI) is running at about 1.5.

The overall PCR (OI) is at about 1.45. More calls were opened in the past two sessions compared to puts. I think a fair amount of this is hedging volume "� the stock and index futures segment suggests that bearishness is expected.

Technically speaking, the market is likely to see drop further with however, the likelihood of a temporary pullback in the next week. In the perspective of the next 5 sessions, we're most interested in the range between Nifty 4,300-4,550. There's a strong support at 4,300 and powerful resistances between 4,500-4,550. Volatility is very likely to remain high.

There's also ample liquidity in the option chain across this entire range. However premiums on the near-money calls are higher than comfort levels because the market has fallen so fast.

Assuming Monday remains weak one would expect a drastic drop in call premiums. Using the converse logic, puts are somewhat under-priced and premiums may rise.

Working on current premiums, bullspreads with long 4,450c (115) versus short 4,500c (91.5) or short 4,550c (71.65) cost 24 and 44 respectively with the maximum payoffs being 26 and 56. These are not very favourable risk-reward ratios. The bullspread with long 4,500c versus short 4,550c offers a better risk-reward ratio with a cost of about 20 and a maximum payoff of 30.

Again, on current premiums, bearspreads with long 4,450p (164) versus short 4,400p (140) or short 4,350p (120) cost 24 or 44 respectively, with maximum payoffs of 26 and 56. Exactly the same risk-reward ratios as bullspreads. Again a long 4,400p versus short 4,350p costs 20 and pays a maximum of 30 and seems like a better position than the on-the-money spread.

Spreads in either direction could work but ceteris paribus, a downwards move seems more likely. So if premiums don't change that much, one would advice taking bearspreads. A long straddle at 4,450 costs about 280. The breakeven would come at 4,170 or 4,730.

Both seem unlikely prices to pop up in the context of next week. A long straddle with long 4,550c and long 4,350p costs about 192 and breaks even only in a market that goes beyond 4,160-4,740.

We could try the short straddle at 4,450 coupled to a long strangle. The premium inflow is about 88 and the maximum loss is very low - because the breakeven points are so close.

STOCK FUTURES/ OPTIONS

The stock F&O segment is likely to see significant arbitrage action. For example, GMR Infra (Future 876.6, Spot: 870), Reliance Energy (Future: 769.5, Spot: 762.65) Rel Caps (futures: 1,206, Spot: 1,194 ) and RIL (Future: 1,882, Spot: 1,867) all present potential arbitrage opportunities.

In each case, the normal action for an arbitrageur would be to sell the future and buy the spot. This is another reason to expect a temporary recovery. In each case, the retail trader could try to "piggyback" either market.

On Tuesday, there is likely to be action across the financial sector stocks as the RBI comes through with its policy update. The BankNifty has already been hit harder than the rest of the market in anticipation of harsh measures.

If the central bank does not hike rates or squeeze money supply, there will be a relief rally. If it raises rates sharply, the rally could be quite strong.If you have the nerve, pick a basket of bank stocks "� SBI, ICICI and PNB for instance, and go long.

As for long positions, ITC is obviously rallying on stock-specific news and rumours. The other potential long position that seems very stock-specific could be BILT. The stock has jumped and a long futures position at 132 could be worthwhile. Keep a stop at 129.