Look at strangles and straddles

Derivative traders have a chance to go short and make money in a weak market.

There was persistent bearishness through the week both in Indian stocks as well as across global bourses. Derivatives traders have a chance to get on the short side in a market that shows thinning but adequate volumes.

Index strategies
Futures and options turnover by Thursday was down below Rs 60,000 crore, off almost 40 per cent from its heights. Open interest showed similar declines with intra-day traders unwilling to leave overnight positions.

The FIIs maintained their share of around 35-36 per cent of total derivatives exposure and the break-up showed little sign of a shift in attitude which is apparent in cash where they have indulged in massive selling.

The Nifty's liquidity hasn't been affected that much but the volume contraction has definitely hit the stock futures segment and other less-liquid indices.

This sort of low volume cycle can make life difficult for the trader because it can cause spikes in price volatility and hence lead to margin calls.

Apart from being cautious about overnighters, it would be prudent to keep say, an extra 20 per cent in hand to handle sudden emergencies.

The Nifty closed at 5663 in spot on Friday. However the derivatives trading on that day was spotty with volume only in the November futures which was last traded at 5590 when the spot was 5614.

On Thursday, the November Nifty was held at 5709 with spot at 5698, December at 5700 and January at 5684. Open interest expanded across all three series.

On Thursday, the Junior closed at 10460 in spot, while the November contract was settled at 10483. The CNX IT closed at 4461 with November settled at 4457.

The Bank Nifty closed at 8876 with November settled at 8967. Given all these underlyings dropped on Friday, we can expect a sharp correction on Monday when there is active F&O trading.

The Nifty differentials are not worth trading "� a naked short is possible. If our bearish projections hold, the Bank Nifty (which lost 7 per cent in the first four sessions of the week), is more vulnerable to a downturn because the future was held at considerable premium to the spot. A short position here should work -- the Junior is also liable to see a payoff from a short position because the future was at some premium.

In the options segment, the Nifty put-call ratio (open interest) has declined a little but it's still positive at 1.1. However call open interest is expanding almost thrice as quickly as put open interest while call premiums are falling and put premium rising. To my mind, that's a signal of a bearish market where net sellers are hedging with long calls.

In terms of technical views, the Nifty is still displaying very high volatility and this is likely to be accentuated if volumes stay low. Expect the market to continue registering daily 300-point high-low ranges.

The Nifty has some support at 5650 and lower down at 5600 and then,5525. Those supports could be tested next week. On the upside, a move above the 5900 mark looks unlikely since the market is exhibiting bearish signs. So traders should probably look at the range of 5500-5900 in the coming week.

A bullspread of long 5700c (138) versus short 5800c (98) costs 40 and pays a maximum of 60. A bearspread of long 5700p (252) versus short 5600p (210) costs about 42 and pays a maximum of 58. The risk:reward ratios are almost the same but the bearspread is in the money. A straddle of long 5700p and long 5700c costs about 390 and hits breakeven at either 5300-6100.

Given the high volatility, we should consider wider spreads. A long 5800c (98) versus short 5900c (75) costs 23 and offers a maximum payoff of 77.

A long 5600p (210) and short 5500p (168.75) costs 41 and pays a maximum of 59. If we combine these positions, we get a long strangle and short strangle combination, which costs an initial 65 and pays about 70 if both legs of the strangle are hit. If one leg is hit, it will pay about 35.

There are two other possibilities. One is a very wide long strangle of long 5500p (168.9) and long 5900c (75). This costs 244 and it makes breakeven if the market moves beyond roughly 5255-6145. The rationale would be that it gains on a big breakout in either direction.

The breakeven range is approximately the same as with the 5700 straddle. That means, we can contemplate a short straddle at 5700 covered with a long strangle at 5500 and 5900.

The initial inflow is about 145 and the maximum loss if one leg is hit is about 55. This position seems to be close to bullet proof assuming no massive premium changes.

STOCK FUTURES/OPTIONS

The speculative bullish action seems to be focused on PSU refining counters with rumours that a price hike is in the offing. The other area of bull-focus is aluminium stocks such as Hindalco and Nalco.

Apart from this, bull action is scattered across specific counter without much in the way of a theme. The best dark horse appears to be GMR Infrastructure which saw a bullish pattern on Thursday.

On the short side, the safest bets seem to be going short on banks such as HDFC Bank and PNB. Infosys is another potential short, having dropped below a key support at 1750.

RPL and RNRL have taken a hammering but both counters are iffy. RPL is on the ban list so it can't be traded while RNRL showed signs of support on Thursday.