Catch that calendar spread

The difference between May and June future is larger than normal, which means one can bet on a calendar spread by selling May and buying June at current rates.

The market enters settlement week in a very unsettled frame of mind. After the massive sell-off of last week, prices could move in any direction.

There could be a big pullback sparked by short-covering or a further big loss if panic continues. Given leveraging and hedging possibilities, huge fortunes are at stake in the next four sessions.

Index strategies: In the past five sessions, open interest has dropped across the May Nifty futures and in the Nifty put options segment. However, it has risen sharply in the May call segment.

Nifty spot closed at 3247 on Friday, while May futures closed at 3224 and June futures at 3205. The Nifty put-call ratio has fallen to 0.6, which has been the lowest level in several months "� generally the PCR has traded well above 1 throughout the bull run.

Technically speaking, the low PCR suggests that the options market is overbought. This could indicate another sharp crash. Intra-day volatility has been extremely high and is likely to remain so until settlement at least.

In comparative terms, the IV is lower than the recent volatility suggests it should be.

Despite the high PCR, we could expect a recovery of sorts. The Nifty has excellent support in a band between 3175 and 3250. I would say it's likely that the market will bounce off the lower end of that zone. It is entirely possible that short-covering could drive the index temporarily up by 150-200 points.

At the very least, expect moves between 3175 and 3350 and more likely between 3150 and 3450 in the next four sessions. Despite the looming expiry, uncovered option-writing will be highly risky.

In the futures market, a calendar bear spread is marked "� the difference between May and June is larger than normal. If you sell May and buy June at current rates, you may be able to lock in the difference on the enforced reversal.

Again, the anticipation of high volatility makes it possible to contemplate fairly wide spreads, despite expiry risk.

A standard bull-spread with long 3300c (73.75) and short 3400c (42) costs 32 and pays a maximum of 68. A narrower spread with long 3300c (74) and short 3350c (56) costs 18 and pays a maximum of 31.

Both offer excellent risk-return ratios though the realisation of either spread implies a minimum 100-point move. A standard bear-spread of long 3200p (84) and short 3150p (68) costs 16 and offers a maximum return of 34. This is also an excellent ratio.

If we combine a bull-spread with a bear-spread, effectively creating a long strangle at 3200p and 3300c, we will pay a net premium of 34 for a possible return of 16, if either side of the position goes into the money. That's not too useful at the first glance but there is a chance both sides of the position will be in the money at some stage. However, this isn't worth gambling with just four sessions to go.

To sum up, both bear-spreads and bull-spreads have decent risk-return ratios. I think there's a greater chance of a big rebound rather than a big fall inside the next four sessions. So, I would choose a bull-spread. However, any position carries a huge risk. You could end up losing the entire premium outlay.

The other two tradeable indices are both at negative carry. The Banknifty is at 4330 in the spot market and 4308.55 in the May series. The spot CNXIT is at 4027 while the May CNXIT is trading at 4005. Both futures have seen lower OI in the past couple of sessions.

It seems reasonable to go long on the May series though this carries some risk if the market drops more. I would be slightly more bullish on the CNXIT for the sole reason that the rupee is likely to come under further pressure.

STOCK FUTURES/ OPTIONS

There's no point in looking at stock options with such a short time to expiry and low liquidity. In the stock futures market, we have a magnified version of the same risks that exist in the index derivatives market.

Expect similarly high levels of volatility and unpredictable movements. The absence of option liquidity makes it difficult to hedge risks inside the derivatives segment itself. Futures positions are symmetrical in terms of risk:reward.

Due to the last week's trends, most futures are trading at some discount to the spot price. If you own the stock in question, you could sell the stock and buy the future to lock in the difference by reversing on settlement. Bajaj (1.8 per cent), Bhel (2.3 per cent), Cipla (2.2), Tata Chemical (3.2 per cent) offer fairly large differentials.

It's difficult to suggest too many naked futures positions due to the unpredictability of trends at this instant. We've had a strong downtrend over the past 7 sessions.

The reaction, when it comes, is likely to be quite powerful as well. If you're caught on the wrong side of a futures position in those circumstances, it will be quite unpleasant.

In general, you'll have to keep stops at about 2 per cent off the trade-price in order to avoid whipsaws and with futures leverages that could burn a big hole in your pocket.

Bajaj, Dabur, Infosys, HDFC Bank, Mahindra and NTPC look about the best long futures positions inside the May settlement. On the short side, Hindalco and Sterlite could fall a bit further and Bhel, Bharat Forge, Tata Motors, Jet Airways, Maruti, ONGC and Siemens are other possible shorts.