Considering the prevalent market uncertainty, July contracts could be avoided as they suffer from insufficient liquidity
Last week saw falls across the F&O market being triggered by the fall in spot prices. Of course, apart from the natural panic, there was also the pressure of Thursday settlements. After adjusting for that confusion, we can see that Put premiums generally rose while Call premiums fell.
Our assessment is that the market is unlikely to rise significantly. It may continue to see more bearishness, trading somewhere between Nifty 960-1010. Alternatively, it could remain neutral (Nifty 1000-1025) in the short-medium term. In the least likely of circumstances, where the sentiment changes, the maximum level it could rise to is around Nifty 1040.
This timeframe covers most of April and possibly May as well. We also feel that the bearishness will peak sometime in late April and there will some recovery through May. That is, our longer-term perspective is more bullish than that of our shorter-term.
The F&Os worth concentrating on include Nifty instruments and IT stock options and futures. IT stocks and their derivatives are volatile and high-beta as well as liquid.
In such uncertain circumstances we would like to keep the exit door open, being prepared to sell off instruments before maturity, taking either a profit or a loss on the premium difference. In broad terms, the implied volatility of in-the-money instruments seems rather high and most stock futures are showing effective backwardation.
Liquidity is key to the situation. We can safely ignore most July instruments when formulating strategies in accordance with our view because most of them are very illiquid. Unfortunately, May F&Os aren't very liquid either at the moment.
The following is a list of possible positions given our views.
Potential Index Spread/Combinations
Buy May Nifty Futures (1002) and sell April Nifty Futures (1001). This works brilliantly if there's a further fall in April followed by a rise in May.
It also gains if just one of these events occurs. In basic terms, this bear spread will appreciate in value if the difference between April-May (currently almost zero) increases in a positive direction. What we don't want is a rise in April coupled to a fall in May. Be prepared to reverse by buying April and selling May even if there's just a small profit to be obtained.
A straddle at Nifty 1000 with an April Put and April Call is reasonable. The combined premium is around 30 so we're hoping for a move outside the 970-1030 range if we hold these European Options till expiry. In practice, we're hoping for a swing in either direction when we can cash a profit on the appropriate premium. That could be followed by a swing in the opposite direction.
Keep a lookout for a possible Diagonal Bull Spread. This involves, say, selling an April Nifty 1030 Call and buying a May Nifty 1040 Call. Right now, May is illiquid and unavailable. However, that will change as time passes. We are hoping for an initial credit in premium, although that may not be possible.
Our maximum gain will occur if the April Call expires with the market close to the strike at 1030 followed by the second Call being in-the-money in May. Our downside is limited to the difference in strike plus/minus the initial debit/credit in premium.
Equity plays
With IT industry stocks, the safest play is probably a hedged bear spread. For those who hold the stock, selling out-of-the-money Calls might work. Swallow the premium if the strike is not hit while capping the downside.
Satyam 210 April Calls are going at about 3 while Satyam 220 April Calls are available at around 1.65. We could also create a bear-spread with these two instruments: Selling 210 Satyam Calls and buying 220 Satyam Calls for the limited gain of the premium difference of about 1.35 and a downside restricted to the difference between strikes (10) minus initial credit (1.35).
Satyam is a highly volatile stock currently trading for around 192. A long straddle with the 190 April Call (11) and the 190 April Put (7) caters for the possibility that it will move outside the 172-208 range.
This seems slightly expensive - there is resistance at 205 while there is support at 190 and 175. Try a short straddle instead, selling both the on-the-money Put and on-the-money Call. There should be some profit in this spread with an initial payoff of 17.
A Calendar Bear Spread with a sale of April Satyam Futures at 192 combined with a buy of May Satyam Futures at 195 also seems possible - the difference between these two Futures prices should increase.
In the case of Infosys, the stock is trading around Rs 4270 with a possibility of falling to around the Rs 4100 mark or lower. The Bear Spread with minus 4300 Call ( 107 ) and plus 4400 Call (65) would seem to net 42 while restricting the possible downside to 58 in the unlikely event of an upmove.
A near-the-money straddle would be the 4300 Call (107) and 4300 Put (153). Once again the combined position is expensive with a positive pay-off only outside the 4040- 4560 range. So it's a decent try to take the Infy short straddle.
But a Calendar Bear Spread, with sell Infy April Futures (4254) and buy Infosys May (4248), looks to be the best strategy. The market's done with the two instruments already at nominal backwardation. Any improvement in May prices or further decline in April prices should lead to profits.
Other equity derivative positions
Hero Honda at the spot price of Rs 196 appears to be in an extremely bearish phase with a possible downside of around Rs 170-175. The 190 Put is probably under-priced at 4.
A naked put is possible. So is a straddle with a 190 Call (11) and 190 Put and a total initial cost of 15. The stock is quite likely to break upwards again before running into resistance at about Rs 205.
