Go for wider spreads

DERIVATIVES

The technical recovery is likely to push the market back to Nifty 2000 levels.

As usual, settlement week dawns with the market in turmoil. Our view is that the technical recovery could push the market back upto a level of Nifty 2000 before it ran into very powerful resistance. Most likely next week will see trading between 1950 and 2000 levels with some chances of a wider range of 1900-2000. 
 

Nifty key stats
	Last week	Previous week	Abs.  chg.
1-m pre/(disc)	-16.4	-16.25	0.15
2-m pre/(disc)	-19.6	-16.4	3.2
3-m pre/(disc)	-18.85	-12.8	6.05
Futures OI*	1007.01	659.82	^52.62
Options OI*	546.4	371.66	^47.02
Put-call ratio	0.82	0.77	0.05
Put-vol. indicator	1.01	0.9	0.11
* In lakhs  ^ % change

Open interest has shot up in both the futures and the options segments. The Nifty put-call ratio has also risen and it's heading into oversold territory. The Nifty futures are all trading at considerable discount to spot and there's backwardation with respect to May Nifty versus April Nifty.

Index strategies: In the futures market, buying April Nifty is an obvious try. With only four days to settlement and OI building up in a bullish market, April Nifty is almost bound to rise to match spot. Can we also buy May Nifty on the same logic?

Yes, and if it's a choice between a single long April and a single long May future, you might want to try May. My preference would be for April because of the enforced reconciliation on Thursday, which means that the future must gain if the index holds its current level.

But if we intend to hold positions across April (1950.95) and May (1947.75), it seems more sensible to hold a long April and a short May. This would gain if the differential between them widens. The inverse position, a bear-spread consisting of short April and long May would require a situation where the May future rose sharply enough to overcome the backwardation and a likely rise in April.

In the options market, we have the usual dilemma of approaching expiry date in April series' and not enough liquidity yet in May. We also have the potential for high volatility; so selling options anywhere close to money is dangerous.

An April options bull-spread of long 1970c (11) versus short 1980c (8.15) has the excellent ratio of a potential 7.25 return to a 2.75 risk. Wider spreads like long 1970c versus 2000c (4) also have excellent risk-return ratios. Balance the expiry factor against that. It may still be worth a risk.

An April bear-spread of long 1960p (23..45) versus short 1950p (17.95) costs 5.5 so the ratio is adverse since only a maximum 4.5 return can be expected. The difference in the ratios shows quite clearly that the market expects more bearishness. The two spreads have been graphed, clearly showing that the bull-spread would pay more if triggered versus lower losses if it wasn't.

Strangles and straddles are interesting because, despite the time-factor, positions can be constructed that might credibly be struck by Thursday. Close to money, a long 1980c (8.15) and a long 1950p (17.95) costs 26. This straddle works only outside 1925-2005. If we sell a 2000c (4) and 1930p (9.95), the position would cost 14 and the net cost of a long strangle-short strangle combination would be 12.

In that case, the combined position would be profitable outside 1935-1995. This is close enough to be triggered even inside four sessions. The opposite combination of short strangle close to money coupled to the long strangle as hedge is not going to work because of the narrow range of payoff.

STOCK FUTURES/OPTIONS

The two big stories of the week were Satyam and Wipro because both delivered excellent results. Wipro options are illiquid but with spot at 644, we could try to take either a naked long April Future (641) or a long April coupled to a short May (641) Future. 
 

Major prem/disc* movements in stock futures
Stocks	Last week	Previous  week
Tata Motors	-1.03	0.2
BEL	0.1	-0.85
Bajaj Auto	-0.06	-1
TCS	-0.52	0.33
ICICI Bank	-2.8	-3.58
Hero Honda	-0.85	-1.63
Oriental Bank	-0.74	0.02
Infosys	-0.61	0.08
Cipla	-0.25	0.41
Gujarat Ambuja	-0.59	0.06
* Prem/disc as a % of cash prices

In Satyam, with spot at 405, a long April (402.8) is worth a punt as is a bull-spread of long April (402.8) versus May (402.85). An option position of long 410c (3.9) versus short 420c (1.9) costs just 2 and it could pay upto 8.
 

Stocks with highest changes in options OI
Stocks	% change	PCR*
HCL Tech	192.57	0.15
Gujarat Ambuja	120.1	0.16
TCS	118.94	0.06
Satyam	110.02	0.48
Wipro	81.43	0.1
Oriental Bank	68.13	0.27
SBI	65.47	0.48
Tata Steel	61.97	0.31
ACC	57.72	0.52
Maruti Udyog	55.14	0.25
* Put-call ratio

 

Both TCS and Infosys have gone through hammering followed by partial recovery in the last fortnight. Both currently have price trends that are difficult to read. Neither offers useful positions in the April settlement period.

Apart from the Ice sector, there were a host of other stocks that looked like potential buys in the futures market. 
 

Stocks with highest changes in futures OI
Stocks	% change	Future 1-m price
Hero Honda	62.64	502.2
TCS	55.81	1160.65
Bajaj Auto	54.75	1079.55
Oriental Bank	44.57	286.8
HDFC Bank	40.41	536.1
Satyam	34.92	402.8
Wipro	34.52	641.4
Gujarat Ambuja	34.19	432.05
Nalco	33.78	160.3
Reliance Ind	32.35	547.55

In the futures segment, ACC, Arvind, Ashok Leyland, Indian Hotels, Maruti and OBC all looked bullish and likely to be settled at gains. However, option positions would be more difficult to acquire due to varying degrees of liquidity and also less likely to be struck.