Bearspreads look tempting

You could toss a coin to decide which direction you wish to play the options markets.

Turmoil continued in the derivatives markets, which was not surprising, given the continuous selling in the equity markets. The volatility seems almost certain to continue until the end of the June settlement at least.

It is possible and indeed likely, that we are in the first wave of a new long-term bear market. In that case, the entire trading pattern in the derivatives market is likely to realign.

Index strategies
The Nifty hit a low of 2683 on Thursday before recovering to 2866 points on Friday. In the next 10 sessions, the market is likely to wander between 2675-3250.

A breakout beyond either of these levels would have interesting implications. A downside breakout would mean that the bear grip is getting stronger, while a rise beyond 3250 would suggest that the intermediate trend has changed for the better.

In the futures segment, open interest eased through the first four sessions of last week. The June Nifty future was held at 2831 points, the July Nifty future was at 2812 and the August Nifty was at 2782 points.

These discounts are substantial, which is also indicative of an anticipated bear market. A calendar bearspread of short June future, long July future could pay off regardless of market direction because the two series should align close to settlement.

In the options segment, open interest increased on Friday. The put-call ratio for June Nifty options is around 0.58 which is again indicative of bear-market behaviour.

The PCR has tended stay above one for long periods during bull markets and it has dipped below one in mid-May and stayed below one, ever since.

The implication is that the market anticipates further losses since it is technical overbought. A standard options bullspread with long 2900c (96.4) versus short 2950c (78.6) costs about 18 and pays a maximum of 32.

A standard options bearspread with long 2800p (117.4) versus short 2750p (96.5) costs 21 and pays a maximum of 29. The risk:reward ratios for both sets of trades remains surprisingly good, given the amount of volatility we have seen.

In fact, Implied Volatility has shown up in the rise of option prices but the spreads still seem to remain more lucrative than one would expect during a period of sustained volatility. Either sets of spreads could work and quite possibly both.

As of now, the bearspreads look more tempting because of the technical perspective but this may be deceptive. It would take very little to push the index up by 100 points in a temporary surge and that's very likely to happen sometime before settlement.

You could toss a coin to decide which direction you wish to play the options markets. The other tradeable indices, the Bank Nifty and the CNXIT, both suffer from lack of liquidity in anything other than the June futures series.

There isn't much in the way of apparent opportunity in the CNXIT "� the June future is trading at 3575, while the spot is held around 3608. The technical perspective is more or less neutral.

The Bank Nifty is trading at 3829, with the June future last held at 3762. OI has dwindled in the index. I suspect that the sector is due for a small recovery and it may be worth going long on the June future. Several major banks have promising pricelines and the market could respond to a rupee stabilisation.

STOCK FUTURES/ OPTIONS

The action in the stock F&O segment is easily described. There has been very high volatility, dwindling open interest, large amounts of arbitrage and the action has been concentrated on the stock futures segment with very little in the way of options liquidity.

This pattern is likely to continue until the end of settlement. Arbitrage has kept the discounts in the futures market to relatively small amounts vis-a-vis the stock price.

Nevertheless arbitrage plays remain possible and indeed, worthwhile. If there is a one per cent differential between spot and futures prices, the trade seems safe. If you can, buy the future and sell the stock. If you don't possess the stock, it may still be worth buying the future and attempting to piggyback the arbitrageurs. Such positions would have to be held until settlement however.

For technical reasons, among the stock futures segment, I would be willing to go long in banking stocks and in several counters scattered across the erstwhile Reliance Group. Banking stocks do show signs of a possible recovery after several months of underperformance.

In particular, I would look at long positions in ICICI, HDFC Bank and PNB with a potential long position in Oriental Bank as well.

In the former Reliance Group, Reliance Energy, Reliance Industries and IPCL, all show signs of being set to bounce. The new listing, Reliance Petro may be settling down after a spate of hammering. Long futures positions in all these underlyings could work.

These positions would probably also need to be held until settlement but there's a chance that these stocks will rise a little earlier than that. It is possible to take an options spread in RIL. The spot is at 923 and a long 940c (30.55) versus a short 960c (23) costs 7-8 and pays a maximum of 12-13. That's a reasonable risk:reward ratio.

On the short side, the pullback on Friday scrambled the technical position. It seems very likely that the slide will continue on Monday. But almost every stock in the F&O segment saw a recovery in the last session, albeit usually on lower prices. So it's impossible to set reasonable targets for short positions.