Focus on December options

DERIVATIVES

In the November option series, the bear spread has the best risk-reward ratio.

A very volatile, thinly-traded month may end with huge swings in settlement week. Short-covering on last Friday broke a six-session downtrend and the recovery could continue on Monday.

Index strategies:
Lower volumes and higher volatility are perhaps the most dangerous combination for traders. However, it becomes a little safer to play such a market if there is a clear trend to trade. The six-session drop established a trend and led to more positions created on the short side until Friday, when there was frantic short-covering.

The FIIs have mixed a pattern of massive selling in the spot markets with large index option exposures. This is classic for prudent hedgers who are net short. They are likely to be net spot buyers in the next few sessions as they unwind shorts.

Indian operators are following a more dangerous strategy of being net short in both futures and cash. Again, they are likely to start unwinding. That should ensure the uptrend continues until settlement - expect the next four sessions to be split 3-1 in favour of uptrends.

But the one down-session I'm expecting could be a very big one. There will be massive intra-day volatility with the Nifty moving 250 points on average. It's difficult to judge carryover levels but it's likely to be on the low side.

In terms of index futures, the Nifty was held at 5608 in spot while the November futures were settled at 5619.75 and December at 5606. January was settled at 5602. There's reasonable open interest in all three contracts and, while 20.8 lakh November contracts were closed, open interest grew by 24 lakh in December.

Unusually for this stage of settlement, about 3,800 January contracts (out of previous open interest of 158,000) were closed out. So, carryover is positive and I guess there are some calendar spreads of December-January in the picture.

The differential between November-December is just about large enough to trade with a short November- long December calendar spread.

Among the other indices, there was as usual, little liquidity in the mid-month and end-month. The Nifty Junior was 10949 in spot and November settled at 10958.75. The Junior incidentally was the index that lost the least ground last week.

The CNX IT was at 4239 in both spot and November with December (open interest of 4900) held at 4213. The Bank Nifty was 8978 in spot, 9043 in October and 9049 in November (1100 open interest). There was positive carryover with new contracts opened in December exceeding those closed out in November.

The CNX IT's discount seems to suggest that the market continues to be bearish on IT. But the rupee saw a dip on Friday and forex traders say that there could be a continuing technical correction. At least two or three IT majors including Infosys and TCS appear to have bottomed, at least temporarily. So there is a case for going long.

The Bank Nifty is the most interesting. It has good liquidity across November-December and the November future is at significant premium to spot though that difference was mainly caused by short-covering.

It does suggest that a naked long future could pay. However the November-December difference is not enough to trade. If you go long, buy the December Bank Nifty future.

In the Nifty options market, there have been interesting developments. The put-call ratio in terms of open interest dropped to around 0.9 from the 1.2 levels it was at through the first three weeks of November.

This change in the put-call ratio is true for November options as well as for total open interest. Open interest has expanded a lot across both November, unusually at this stage of settlement. However, new calls far exceed new puts across all three periods.

A low put-call ratio is a bearish signal "� it suggests an overbought market. The creation of new options with just four days to expiry suggests either 1) traders have clear views "� bullish given a preponderance of calls or 2) they are going net short and using calls as hedges.

In either event, the put-call ratio is emitting overbought signals. This doesn't jell with other signs of short-covering. That is why I expect at least one bearish session where support at Nifty 5400 is tested. Technically, it would be best to expect a move between 5350-5750.

Spreads using November options run foul of the expiry factor and December premiums are high. But the promise of high volatility makes it possible for a trader to stay far-from-money and risk:return ratios are good across both settlements.

A November bull spread of long 5700c (68.65) versus long 5800c (39.2) costs 30 and pays a maximum of 70. A December bull spread of long 5700c (216.85) versus short 5800c (180.55) costs 36 and pays a maximum of 64. A November bear spread of long 5500p (61.4) versus short 5400p (40.5) costs 21 and pays a maximum of 79.

A December bear spread of long 5500p (222.1) versus short 5400p (189.1) costs 33 and pays a maximum of 67. The December risk:reward ratios are good enough. If you decide on November options, pick the bear spread since that has a great risk-reward ratio.

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STOCK FUTURES/OPTIONS

Short covering is likely to continue across most of the stock segment on Monday at least. However, the trend is very volatile and overnight positions are generally better avoided. The usual suspects from the Ambani stables are generating most of the volume.

Reliance Energy is perhaps the best long shot here. Apart from that, Jindal Steel would be an interesting long position and so would be NTPC. GMR Infrastructure and IFCI will see a lot of volatility in spot because both are on the ban list.