Markets appear mildly oversold

DERIVATIVES

A standard bear spread looks interesting.

Another great week for bulls concluded on a slightly muted note. There were signs of a sell-off on Friday before prices perked up again. Our view is that this could turn into a short-term correction next week. But given the strength and breadth of the rally, we are likely to see net gains by the weekend.

Index strategies
The spot Nifty closed at 3663 with the May Nifty held at 3644, June at 3634 and July at 3624. Our view is that any short-term correction should find support between 3575-3600. On the upside, it's tough to set targets but 3675 seems to be an important resistance.

Daily volatility has eased up in the past week but this could increase again in the event of a correction. Open interest in the Nifty futures remained at around the same levels as it was a week ago but open interest in Nifty options rose.

The put-call ratio for the major index moved to 1.72 from values of 1.31, a week before. The rising put-call ratio suggests that the market is mildly oversold "� an indication that contradicts other technical indicators and suggests that corrections will not be very severe.

The differential in the spot and futures values of the Nifty is difficult to arbitrage. We can exploit the differential between the May and June futures with a bear spread of short May Nifty versus long June Nifty. This locks in the 10-point discount to June and gains as that will disappear near settlement.

In the options market, a standard bull spread of long 3650c (76.5) versus short 3700c (52.4) costs about 25 and pays a maximum of 25. There is inadequate liquidity to set up bull spreads involving short positions above 3700c. The 3650-3700 bull spread is technically in the money already but it would only pay off above the 3675 level "� that is a resistance as we pointed out earlier.

A standard bear spread of long 3650p (78.15) versus short 3600c (60) looks a more interesting proposition in terms of the risk:reward equation. It costs about 19 and pays a maximum of 31. This position is also likely to be fully realised in the event of a correction. So we could recommend a bear spread in preference to a bull spread.

If we took both these positions together, in effect we have a long straddle at 3650 combined to a short straddle of short 3600p and short 3700c. The net cost is around 43 and the maximum gain is about seven. If we reversed this position and sold the straddle at 3650, we would be left with an initial premium inflow of around 43 and this position stays profitable if the Nifty stays inside approx 3610-3690.

Our view is that it will move outside these bounds, so it's not a great position either way. The other indices present interesting pictures. The CNX IT spot was held at 4391 with May CNX IT at 4401, June at 4345. The Bank Nifty saw a spectacular seven per cent rise last week to close at 4877 with the May Bank Nifty held at 4906. Unfortunately, there's no liquidity in the June series.

The considerable premium in the futures series makes it very tempting to sell the future and buy a set of high-weighted bank stocks to create a portfolio that mirrors the spot index. This would lock in the differential since any price fluctuations can be eliminated by reversing the two positions.

The other possibility is to go long in the May series under the assumption that the index will continue to rise. But the technical view is that this was technical bounce, which may not be sustainable.

STOCK FUTURES/ OPTIONS

The market breadth was good but the gains were unevenly distributed. Most of the index contributions came from bank and pharma stocks with some bullishness in the energy sector as well.

The picture in the bank sector now looks mixed. PNB, SBI, Kotak and Corporation Bank appear to have topped out "� one could go so far as to suggest that PNB and Corporation are worth shorts, while SBI is likely to range-trade. But Bank of Baroda, Bank of India, Syndicate Bank and maybe HDFC Bank could continue to run up. Of these, BoI and Syndicate look like the best futures positions.

Among pharma stocks, Ranbaxy, Dr Reddy's, Cipla and Sun Pharma look interesting. Dr Reddy's is swinging through a wide range and either a long or short futures position could work at the present moment.

Unfortunately there's zero liquidity in the options segment. Cipla and Sun Pharma look quite bullish while Ranbaxy could see a correction or range-trade for a while before moving up again.

Long futures in Cipla and Sun could pay off. The third interesting sector was PSU energy and refining stocks. Here Gail, HPCL and ONGC look to be worth long futures positions.

There was scattered across most other sectors "� Reliance Industries, VSNL, GE Shipping, Indian Hotels and Mahindra were among the more prominent gainers. Each of these seems promising "� perhaps VSNL and GE shipping are the most promising in terms of having the clearest technical patterns to support .long futures positions.

Reliance is one of the few F&O counters, which actually has decent liquidity in the options segment. ONGC is another counter with good options liquidity.

A bull spread in RIL with long 1110c (46.5) versus short 1140c (35) costs about 12 and pays a maximum of 18. With spot poised at around 1100, this is a decent position. In ONGC, spot is at 1365. A long 1380c (33) versus short 1410 (24) costs about 9 and offers a maximum of 21. There's a resistance at 1395 but even a rise to that level would put the bull spread in the black.