Go for February bear spread

Despite the expiry factor, a 4100-4150 bear spread is extremely likely to be struck.

Volatility exploded last week with prices swinging wildly through four sessions. This is likely to continue until the Budget session at least and probably into the first ten days of March as well.

The background indicators and implied volatility of premiums changed in the F&O market as traders adjusted to the new reality.

Index strategies
The Nifty closed at 4146 in the spot market after swinging between 3950-4160 in last week. It was settled at 4160 in the February series. The March Nifty was settled at 4158. The settlement comes next week with a distinctly nervous undertone.

The March settlement is long (February 23-March 29) and encompasses the key Budget session. Open interest has already started switching out of the February Nifty series into the March series "� open interest dropped sharply in the February series last week.

There isn't enough of a differential to make a calendar spread worthwhile. The technical position on the Nifty is indeterminate "� the next three or four session will see very high volatility and the index may swing between 3950-4200 all over again.

Given the expiry factor, February futures position are shots in the dark. If you wish to play the volatility in this settlement, Nifty options are a better tool.

Going into the March settlement, it may make sense to go with the herd and take a long Nifty future coupled to a long put as a hedge. However, it probably makes sense to take these positions only after the change-over.

Of the other indices, the CNX IT was up 1.9 per cent in spot and closed at 5805. It was settled at 5800 in the February series "� the open interest is thin. The Bank Nifty lost a huge 5.5 per cent in the spot market to close at 5842 and it was settled at 5858 in the February series. Open interest is better in the Bank Nifty than in the CNX IT.

Both indices are likely to be fairly strong going into the settlement though this is likely to be a short technical phase where the Bank Nifty is concerned.

A long Bank Nifty is a reasonable proposition "� keep a stop at 5785. A long CNX IT looks more sustainable "� keep a stop at 5770. Both are full-margin positions because there isn't enough liquidity in the March series to contemplate calendar spreads.

In the Nifty options market, the February series now has a put-call ratio of 0.9 "� this is a sharp drop from the 1.7 levels of previous weeks. Prima facie, a low PCR is a bearish signal. It is one of the reasons why the Nifty could swing down to support at 3950.

Looking deeper, a lot of puts have been settled while calls have expanded in the past four sessions. The FIIs are the primary users of Nifty options as hedging instruments.

At this instant, the FIIs appear positive "� they have been consistent buyers through February. So, their hedging is likely on the short side. The call open interest has been built up by traders "� the Indian mutuals are negative in attitude but they don't hedge or even use the derivatives market much.

Given the impending switchover, it's worth taking a look at March Nifty options where respectable open interest has already built up. Here the PCR is at 1.9, which is a far more normal ratio and suggests that the trend is likely to be more bullish as the settlement switches over and Budget approaches.

With that technical perspective in mind, let's look at spreads across both February and March. A long Feb 4200c (21.05) versus short 4250c (7.25) costs about 14 and pays a maximum of 36. It expires by Thursday.

A March long 4200c (115) versus short 4250c (91.65) costs 25 and pays a maximum of 25 and stays alive till March 29. A wider March bull spread of long 4200c versus short 4300c (72.9) costs 42 and pays a maximum of 58.

In terms of bear spreads, a long February 4150p (33.4) versus short 4100p (19.75) costs 14 and pays a maximum 36. A long March 4150p (135.6) versus short March 4050p (105.05) costs 31 and pays a maximum of 69.

I would suggest that bear spreads are taken in February options and over a short span. Despite the expiry factor, a 4100-4150 bear spread is extremely likely to be struck. If you want a bull spread, positions across March seem more tempting.

Here the advice would be to wait until closer to settlement or until crossover. Premiums usually reduce dramatically.

STOCK FUTURES/ OPTIONS

In the stock segment, IFCI is in the ban period. There is ample liquidity across both February and March futures series but very little option liquidity in either series. The market lot revisions that come into force from the March settlement will probably mean higher futures volumes since margins will be reduced.

The sector-wise situation seems clear. Go long on telecom stocks (MTNL, Bharti, VSNL, Reliance Communications), go long on IT stocks (Wipro, Infosys, HCL Tech and Mphasis). Go short on bank stocks with the exception of ICICI Bank and Oriental Bank of Commerce.

There is also a potential for taking long positions across the refiner/petrochem space especially in Reliance Industries and IPCL, perhaps in BPCL, HPCL as well.

Among stock specific positions, Hero Honda is potentially attractive and IDFC could be a dark horse. It's developed strong futures volumes and the technical pattern in spot is reasonably attractive.