Bear spread advisable

Go short if you get anything close to the Friday March 9 settlement prices.

A week that was characterised by high volatility ended with very little net change. Open interest and volumes remained high across both cash and derivatives segment. The mood remained bearish with three weeks to go before settlement.

Index strategies
The spot Nifty closed at 3718 with the Nifty March future held at 3698.65, while April traded at 3703.95 and May was at 3704. The Bank Nifty was at 5187.85 in spot with the March index future settled at 5176.5. The CNX IT was at 5198.55 in spot with the March index settled at 5145.85.

All three indices saw nominal net losses and expansions in open interest amidst generally high volumes. Daily ranges were large "� there was a big movement in every session but the overall change was minimal.

So far as the Bank Nifty and the CNX IT are concerned, the substantial discounts make it clear how much the mood has changed.

The futures of these indices have traded at premium to spot through the past year-and-a-half except during the big selloff in May-June 2006. Unfortunately the mid-month futures are not liquid enough to offer meaningful signals or trading opportunities.

Technically, the spot market signals for these indices are also bearish. In the best of both worlds, a trader would short the futures of specific high-weight industry pivotals and go long on the index futures.

This would ensure some gain if the spot levels drop but the futures level off or rise. Otherwise, the contrarian would hold a long future in the hopes that the downside is not as high as the futures discount would suggest.

In the Nifty itself, the mid-term future is trading at a premium to the near-term, which is always a bearish signal. The near-term itself confirms the bearish expectations since it's at a big discount to the spot. A calendar bull spread is possible with long March future and short April future. This would work if there's a bounce, even if the bounce is very temporary in nature.

The index options market offers yet another confirmation that expectations are bearish.

The Nifty put-call ratio is below 1 at the moment "� this is overbought and bearish by definition and in the context of an Indian bull-run it's an extremely strong signal.

Technically speaking, one sees a likely downside of about 150 points in the near term versus a possible upside of 50-75 points.

Oddly enough, the risk-reward relationship is not skewed in favour of going long! A bull spread of long 3750c (75.6) versus short 3800c (56.35) costs about 20 and pays a maximum of 30.

An in-the-money bull spread of long 3700c (117) versus short 3750c (75.6) costs 42 and pays a maximum of 8. If we net off current gains (18) that's a cost of 24 versus a potential gain of 32.

A bearspread of long 3700p (100.45) versus short 3650p (85.25) costs about 15 and nets a maximum of about 35. There's some mispricing here so, go short if you get anything close to the Friday March 9 settlement prices.

The other interesting possibility is a long strangle of long 3650p and long 3750c "� this costs about 160-odd. If we lay it off with a short 3550p (49.95) and a short 3850c (41.5), the net costs drop to about 70.

That resulting position will be profitable if the market ranges between 3820-3850 on the upside and between 3550-3580 on the downside. The maximum gain on a trending move would be about 30.

This position is worth a shot only if you think that the market will swing hard enough to strike both the profit-zones. Well, we are seeing high volatility and there is three weeks left. But the risk:reward ratios look a little adverse.

On balance, the best shot is the plain vanilla bear spread "� it has excellent ratios and it looks the most likely technically.

STOCK FUTURES/ OPTIONS

The stock F&O market is, in a word confused. There is huge open interest in the futures segment and, as usual, very little liquidity in the options market. This is unfortunate because options are a far more flexible instrument when it comes to handling complex hedges.

Most stocks are showing an indeterminate trend with high volatility. Very few stocks appear to have trends that would remain alive regardless of the market's sentiment. Alpha has been drowned by beta.

The big moves in the last two weeks have been market-wide and there are no obvious shorts in the stock segment. There are very few stocks that appear capable of delivering on the upside as well. Most have clear strong support-resistance levels that mimic the index "�pattern.

Bharti and Nicholas are potential long futures positions. SBI is a likely short but the arbitrageurs could get into the act here. The SBI future was last settled at 989 while the last spot price was 979. Selling the future and buying the stock would lock in a reasonable risk-free return despite the long time till expiry.

Assuming this happens, there may be temporary firming up in the spot price. Tata Steel is developing reasonable volumes and it may be bouncing back post-correction. NTPC is another counter, which promises a reward if you hold the long futures position till settlement.

The most interesting position I could find was Hero Honda. The spot price is 691 rising from a recent low of 611. The last futures price was 677. The differential can be arbitraged only via buying the future and selling the stock, which requires delivery. However a long future would work in the same circumstances.