Combine strangles

DERIVATIVES

The market is more likely to move up than down.

Activity seems to have returned to the F&O market which got a shot in the arm with mutuals being allowed to take positions. After two successive weeks of negative divergence when OI dipped despite a rising spot market, volumes jumped last week.

OI rose sharply, the nifty put-call indicator stayed above 1 and the market PCR was held around 0.65. The market is more likely to move up than down. On the downside, there is support at Nifty 2520 and lower down, at Nifty 2500. A reaction should come back to around these levels rather than move further down. 
 

Nifty key stats
	Last week	Previous week	Abs.  chg.
1-m prem/(disc)	-11.25	-12.50	1.25
2-m prem/(disc)	-24.25	-23.45	-0.80
3-m prem/(disc)	-33.05	-35.70	2.65
Futures OI *	1308.30	976.73	^ 33.95
Options OI *	909.30	585.05	^ 55.42
PCR	1.13	1.13	0.00
PVI	1.22	0.86	0.36
* in lakhs ^ % change

Index strategies: The spot Nifty is at 2552 while September Nifty futures is at 2541, October is at 2528 and November is at 2519. Settlement is on September 29. So, we still have a fair amount of time.

My take is that a calendar bear-spread should work well in these circumstances because the differential between September-October must narrow by settlement. Sell September Nifty and buy October Nifty - if the 13 point differential narrows as it must, this position will gain.

A high PCR indicates bullish sentiment through contrarian logic - everyone expects the market to drop hence, it's more likely to go up. In the Indian market though, it seems to occur more because of hedging considerations - people with long positions in spot take a short stance in the options market to protect their holdings.

In this instance, it's obvious that last week, when OI more than doubled, a majority of the new positions were puts. Since the spot market went up with vast amounts of liquidity this could only be hedging.

The effect is likely to be the same - a high PCR translates into bullish expectations. However, a high PCR also means that put premiums close to money are skewed and higher than similarly placed call premiums. This has implications for the trader in terms of risk-reward ratios and the ability to take symmetrical positions based on strangles and straddles.

In the options market, a bull-spread of long 2560c (21.45) versus short 2590c (12.35) costs 8 and it could pay a maximum of 22. That's a decent risk-reward ratio in a market that seems poised to continue upwards.

A put-based bear-spread of long 2540p( 33.45) versus short 2510p (22.1) is the same distance from the money (minus 40 points) as the above bull-spread (plus 40 points).

However, the premium outflow on the bear-spread is 11 and the maximum gain on a 30-point downmove is 19. While this ratio is good, it isn't anywhere near as good as the bull-spread.

When it comes to strangles, the risk-reward ratio is reasonable. A long 2540p and long 2560c costs a total of about 45 and comes into the money only if the market moves beyond 2495-2605.

If we reverse this position taking a short strangle and decide to cover the short position with long 2500p (19) and long 2600c (11.25), the initial combination pays about 25.

The profit function remains positive between 2520-2580 and if the Nifty moves out of this range, the losses are capped at 15.25. So, you could gain from a bull-spread, a bear-spread or a combination of short and long strangles.

STOCK FUTURES/ OPTIONS

In the F&O segment, PSUs appear interesting. In the oil sector, BPCL, HPCL, ONGC and Chennai Petro are poised to move upwards. Every one of these is worth a long position in the futures segment. Maruti seems to be another bullish government-owned company as do IDBI and LIC Housing Finance. These three, too, are worth long futures position. 
 

Stocks with highest change in Options OI
Cos	% change	PCR
Bajaj Auto	800.00	0.43
Jindal Stainless	591.86	0.04
Jet Airways	266.67	0.01
IOB	255.07	0.07
TVS Motors	175.00	0.16
Union Bank	172.47	0.13
Tata Chemicals	165.63	0.04
Bharti Tele	151.38	0.08
SBI	140.38	0.46
Vijaya Bank	133.01	0.06

Until last week, the PSU banks appeared to be strong. However, there was a slowdown in these stocks by Friday and there may even be a small sell off in SBI and BoB this week. I wouldn't be brave enough to suggest a short position though in this market.

Since almost everything in the F&O segment is running up, it's difficult to go beyond a shotgun approach. One way to differentiate between stocks and try and pick up excess returns is by selecting stocks, which are in the early stages of a move. That way, when sector switches results next week, these stocks could be the big winners. 
 

Stocks with highest change in Futures OI
Cos	% chng	1-m futures price
Indian Rayon	208.81	592.90
Maharashtra Seamless	173.65	519.15
Jindal Stainless	147.74	162.25
TVS Motors	123.14	91.45
Colgate	111.61	251.15
Patni Computer	86.31	449.50
IOB	79.33	95.95
Vijaya Bank	70.39	67.65
Union Bank	68.99	139.40
Bajaj Auto	68.09	1648.10

Such a list would include Arvind Mills, Bilt, Hindustan Lever, ICICI Bank, IPCL, NTPC and Tata Steel. Each of these stocks saw buying coming in on last Friday and they seem to have joined the party late.

Maharastra Seamless, Indian Rayon,. Patni and TVS also seem to have a lot of bull supporters lurking in the futures segment "� each of these saw a disproportionate volume and OI expansion. 
 

Stocks with highest change in prem/(disc)*
Cos	last week	previous week
MTNL	0.01	-3.05
Dabur	1.00	-2.05
Neyveli Lignite	0.65	-0.80
Shipping Corporation	-0.19	-2.45
GAIL	-2.30	-5.25
UTI Bank	1.20	-2.05
National Aluminium	-1.15	-3.20
Alok Textiles	0.35	-0.55
ABB	9.25	-8.80
Sun Pharma	-1.75	-7.69
* - prem/(disc) sorted as a % of cash prices

There's also some interest developing in Jet Airways. There are short positions building up in Bajaj Auto and SBI "� in both these stocks OI has risen along with the PCR.