Either spread will work

Both bull and bear spreads have good risk to reward ratio and seem certain to be hit within the settlement.

The derivatives market mirrored the action on the cash side showing high levels of volatility and big intra-day moves. Open interest and volumes continued to grow as spot trading patterns became more choppy.

Index strategies
The spot Nifty closed at 4401 while the August futures were last traded at 4366 and the September futures at 4349. Open interest dropped on Friday but it was still higher on a week-to-week basis. The CNX IT closed at 4886 in spot with the August contract at 4870 while the Bank Nifty closed at 6854 with the August future held at 6862.

The FII attitude is interesting. They were heavy net sellers in the spot market last week. In the F&O segment, they reduced exposures in the index futures segment (where they are net plus) and in stock futures (where they are net-plus). They increased commitments in the index options and stock options segment.

Experience suggests that FIIs use the options segment mainly as hedging instruments. An analysis of open interest suggests that their derivatives exposure is significantly net plus. This means they intend to continue selling spot positions "� good reason for the market to have bearish expectations.

The discount to spot in the Nifty futures and of mid-term to near-term has been unusually high since the downtrend started and this means traders continue to have bearish expectations.

A calendar bear spread of long September and short August is a marked position though we cannot exploit the even larger discount of spot vs near-term. It's a long settlement, so this position may have to be held for another four weeks.

Of the sector indices, the Bank Nifty seems somewhat bullish and the premium of future to spot might increase next week. Long positions in individual banks such as SBI and OBC might make more sense than holding the somewhat less liquid Bank Nifty.

The CNX IT made a downside breakout on fairly high volumes "� this means the sector index could fall further. While the future is at a discount to spot, it may still be worth a short. The danger here is that the recovery as and when it occurs will probably be a 3-4 per cent move in a single session. So it is difficult to set stops or hedge a bearish view.

In the index options segment, the August put-call ratio (open interest) remains at about 1.44 while the overall put-call ratio is about 1.3. One interesting factor is that there has been massive cash outs in August calls (and hence, lower August call open interest) over the past two sessions.

Another interesting factor is that overall call open interest has expanded, including in the October segment. This is unusual because the long-term option chain rarely has much open interest. I think this is partly the FII influence but it could also be traders looking to hedge a prolonged downtrend. Anyway a 1.3 or 1.4 put-call ratio is bullish by definition, which doesn't gell with other market signals.

Given the high levels of intra-day volatility we could expect that premiums would be high and that is true. But we are getting attractive risk:reward ratios for far-from-money positions. Far-from-money spreads seem perfectly viable because the level of volatility is high.
Technically speaking we are interested in swings of between 4300-4500 in the next week. In the context of the settlement (August 30) we are interested in a range of 4100-4600, which the Nifty could traverse in this month.

A bull spread with long 4450c (75.75) versus short 4500c (55.95) costs 20 and pays a maximum of 30. A bear spread with 4350p (110.95) versus short 4300p (93.75) costs 17 and pays a maximum of 33. Both have very nice risk:reward ratio and both seem certain to be hit within the settlement.

If you combine the above positions, you get a covered long strangle with a maximum payoff of 13 versus a premium outgo of 37. That is an adverse ratio. However it is perfectly possible that both legs of the strangle would be hit and therefore we can perhaps expect a maximum payoff of 26 versus a cost of 37. Still not very attractive.

We could also look at wider covered long strangles. A long 4450c and long 4350p costs a combined 187. This can be laid off with a short 4200p (63) and a short 4600c (27). The net premium outgo is 97. This covered strangle thus breaks even at 4550 or 4250 and it has a maximum payoff of about 50 in either direction. Not very attractive really.

So, the most attractive possibility is either the simple bear spread or the simple bull spread. The bear spread has somewhat the better payoff ratio but I have a suspicion that the far-from-money put premiums will probably decline in the next couple of sessions while call premiums may rise temporarily.

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STOCK FUTURES/OPTIONS

T here are two clear sector trends. Banks are up and IT is down. However movements inside these two sectors are very stock-specific. Among banks, SBI and Oriental Bank seem the best long options. Wipro could move against the sectoral trend in IT and as and when there's a recovery, Infosys is likely to lead.

There was scattered investment and very high trading volumes across GMR Infrastructure, IFCI, Reliance Communications, Maruti, Tata Steel, DLF and Reliance Capital. In fact, Reliance Capital could be a dark horse with an upwards spurt in the next three-four sessions. Maruti is also generating surprising