Bear-spread better

The settlement was completed comfortably with prices showing a slight upward trend. Eventually there was high carryover and the foreign institutional investor (FII) influence on derivatives was emphasised as they collectively hold almost 40 per cent of outstanding positions.

Index strategies

The pattern through settlement week was intriguing because we saw stable trading with relatively low volatility. At the end of a month characterised by big price swings, low volumes and high open interest, it was normal to expect that the settlement would be equally volatile. But prices didn't move quite that much in the last week. An upwards bias was expected and occurred because of high levels of short interest. There was high carryover though volumes stayed on the low side.

The FII attitude is interesting. Their exposure in futures and options (F&O) now amounts of close to 40 per cent (it is usually close to 35 per cent) while they remained consistent sellers through November. Large-scale hedging or short futures positions piled on sales backed by delivery? Most likely, a combination of both, given high exposures in both index options and stock futures.

In contrast, Indian operators appear to be buying in delivery (they have absorbed the FII sales of last week) and not maintaining high derivative exposures. This is also an unusual pattern. It may all be very temporary since we are only two days into the December settlement and there could be a resumption of normal service with operators increasing derivative exposures.

In terms of index futures-spot movements, the spot Nifty closed at 5,762 while the November futures was settled at 5,803, December at 5,792 and January at 5,787. There was significant increase in OI across both December and January. No chance of arbitrage, however, the premium to spot suggests that there is some bullish momentum.

Among other indices, the spot CNXIT closed at 4,431 with the November contract settled at 4,438.95. The Bank Nifty closed at 9,375 and it was settled at 9,461 "� the discount is likely to be arbitraged on Monday's opening with the futures opening high. The Junior closed at 11,431 with the futures settled at 11,517 "� again the difference is likely to be arbitraged on Monday's opening.

In the index options market, both the outstanding open interest and the volumes were fair on Friday. More puts were opened than calls and the put-call ratio (in terms of open interest) rose to 1.33, which is a good signal. Close-to-money premiums have dropped a little from the exorbitant levels of November but Implied Volatility (IV) is still a little higher than Historical Volatility (HV).

Technically, the Nifty continues to be range-bound. The market has been unable to break out from either end of 5,400-5,800 and this pattern is likely to continue unless there is a major volume expansion in the spot markets. There is ample liquidity beyond this, till around the 6,100 level.

There is a major asymmetry in the risk-reward ratios of common spreads due to a big difference between call and put premiums. A bull spread of long 5,800c (205.9) versus short 5,900c (146.75) costs 59 and pays a maximum of 41. A bear spread of long 5,700p (162.45) versus short 5,600p (130.5) costs 32 and pays a maximum of 68. This is a huge differential especially in a range-trading market. Obviously it makes more sense to bet on the market falling.

Straddles are uncomfortable at current levels. One of the two options will be significantly out-of-money. If we are looking at strangles, we could go with long 5,900c and long 5,600p for a position that has breakevens at 5,330 and 6,170. This position can be laid off with short 5,300p (53) and short 6,100c (67) for a net cost of about 160. In that case, breakeven will come at 5,440-6,060 and the total payoff on the downside would be about 140 and it would be 40 on the upside. The risk-reward ratios are unexciting.

On balance, the premiums and hence, the payoffs are so skewed, it makes sense to only consider bear spreads. If you are of a determinedly bullish view, take a long futures position rather than go with call options. Or else, sell deep puts at about 5,500p (99) on the basis that these are unlikely to be struck.

Sooner rather than later, the premium situation is likely to correct. If prices stay range-bound, call premiums will shift down. Or the excess put demand will cause put premiums to rise. Or there will be a breakout and a clear trend will be established with premiums shifting to reflect that. However, until the asymmetry is removed, it makes sense to stay away from calls.

Stock Futures/ Options

Several groups of stocks made strong moves on Thursday and Friday and that leaves a lot of possibilities for the bullish trader. The big buzz early next week could just be IT stocks "� the rupee has dropped a bit, even if that is temporary. While HCL Tech and Satyam have already moved up, Infosys and TCS showed signs of being ready to join the party on Friday. TCS looks especially interesting and well worth a long future with a stop loss at around Rs 1,010.

In the bank sector too, there has been an upward trend. Apart from the usual suspects such as SBI, BoB, HDFC Bank, Kotak, a long position in Indian Overseas Bank may be worth a try. Keep a stop at 162 if you go with a long future.

Sterlite is one of several other stocks such as Essar Oil and Neyveli that have been generating consistently high volumes and registering a bullish trend. And of course, there are the Reliance and ADA groups.