Fairly good reward to risk ratio

DERIVATIVES

Close to money bull-spread or bear-spread positions are likely to be fully realised.

The fragility of the current bull-run was highlighted on Friday by rumours that caused the market to crash. In technical terms, although the rumour has been scotched, the correction may continue because it developed quite a lot of momentum.

The major indices and F&O stocks have run up so quickly that the closest reliable support levels are probably the prices prevailing in late March. It is fairly early in the settlement and open interest expanded across both futures and options segments.

Index strategies:
In the Nifty, Friday closing prices came at around 3455 points in the spot segment. The April Nifty futures are trading at 3458, May Nifty is at 3455 and June at 3453. There is a reasonable amount of OI in all three series.

Given the premium to spot in the April series (unusual at this stage in the settlement), the market is mildly overbought. In the Nifty options segment, OI has also expanded a fair amount. The put-call ratio is at 1.46, which would qualify as marginally oversold in the context of this market. The PCR reduced through most of last week.

Our outlook would be that if the correction continues, the Nifty would find reliable support around 3350 levels. That leaves the potential for quite a large drop. On the upside, a renewal of long interest could push the index till the 3510 levels. Hence, traders should be focused on the range of 3350-3510.

There is a lack of liquidity in the option chain between 3450-3500. We can either create a bullspread with long 3450c (71.5) versus short 3500c (49.5) or we can create a bullspread with long 3500c (49.5) versus short 3550c (31.7). the first position (which is "in the money") costs 22 and pays a maximum of 28 while the second position costs 18 and pays a maximum of 32.

However, if our technical perspective holds, the second far from money position is unlikely to be struck this week at least.

If we decide to create a bearspread with long 3450p (67.6) versus short 3400p (47.25), that costs about 20 and pays a maximum of 30. A further from money bearspread with long 3400p (47.25) versus short 3350p (31.8) costs about 15 and pays a maximum of 35.

With the current state of volatility, it is likely that the close to money positions will be fully realised and the reward:risk ratios are fairly good. Hence, depending on perspective, you could take either a close to money bullspread or bearspread. Before the settlement ends, both positions are likely to be struck.

If you decide to go for a strangle, the best position is a long 3400p (47.25) and a long 3500c (49.5). This costs about 97. It can be laid off with a short 3300p (21) and a short 3600c (20.5), pulling in a premium of about41.5. The net position costs about 56 and it would be profitable if the market moved beyond 3350-3550. However the return: risk ratios are slightly adverse.

The other two tradeable indices are also interestingly poised. Our technical perspective is that the Banknifty, (4717 spot) is likely to see a further decline till around the 4635 level. Most bank stocks look weak. The April Banknifty 4751 is trading at a significant premium to the spot so we could sell this series.

A calendar bearspread where we sell the April Banknifty (4751) and buy the May series (4771) is tough to execute since there's a lack of liquidity in May so, it may be better to simply sell the April series and perhaps, buy three or four key bank futures ( SBI, ICICI, BoB and HDFC Bank) to hedge the position. This hedged position would gain if the differential between the Banknifty spot and Banknifty futures narrows.

The CNXIT is at 4348 in spot with the April future at 4387 and liquidity problems in the May series (4480). Again the huge premium in the futures series make it tempting to sell the future and we could hedge with a few high-weight IT stocks such as Infosys, Satyam and TCS.

---

STOCK FUTURES/OPTIONS

Cement shares stayed strong through the chaos on Friday. ACC, Grasim and Gujarat Ambuja all looked to be capable of bucking possible downtrends through the month. Long futures positions in these stocks are possible.

Satyam saw a lot of selling and it may have landed close to a reliable support. This is worth going long. However the April future (822) is at a premium to the spot (816). A long 820c (37.25) versus short 860c (21) is a reasonable position. This bullspread could pay a maximum of 24 on an outlay of 16.

Infosys (spot: 3167) could swing anywhere between 3125-3300 inside a couple of sessions. The April Infy future is trading at 3196. An obvious arbitrage is to buy the spot and sell the future "� this gains if the differential between the two series reduces because it can then be reversed to lock in the profit.

Another possible position is a bullspread with long 3200c (136) versus short 3300c (94) "� this costs 40 and pays a maximum of 60. Another possibility is a bearspread with long 3200p (129) versus short 3100 (79).

This costs 50 and pays a maximum of 50 so the return:risk ratio isn't very favourable. In the futures segment, LIC Housing seems to be another stock that is looking strong and Ranbaxy is a potential turnaround. These could be potential long futures positions.

As of now, plenty of stocks are looking weak. However, we are trading against the long-term trend if we take short positions so there is an additional risk. The most tempting counters to go short are BPCL, HPCL and perhaps Gail and Reliance Energy.