Opt for a bearspread

DERIVATIVES

If the market breaks before November, you can expect handsome returns.

The settlement went off smoothly "� in fact it was characterised by a surprising absence of volatility. The market has been strong through its first session of the November settlement registering high volumes and overall net gains.

Index Strategies
The Nifty is very close to a new high and quite likely to achieve this next week. That is reflected in the fact that index futures are trading at a premium after a sharp increase in open interest across the November and December series.

The spot Nifty closed at 3739 on Friday while the November Nifty futures were held at 3748.7, the December futures were settled at 3748.5, and January is trading at 3745 though there's little liquidity.

The premium between spot and near-term future is unusual "� especially this early in a settlement. So is the fact that November is only trading at decimal point to December "� we would expect a differential of about 10-12 points in favour of the near-term.

This leads us to suggest a calendar bull-spread of long November, short December. That would gain if a differential appears in favour of the near-term future.

Of the other two index futures, the BankNifty and CNXIT, there isn't much volume or OI in December. The CNXIT has barely adequate OI and volume for the November series.

The BankNifty is more liquid. The CNXIT future (4948) is trading at an appreciable premium to the spot (4927.5) while the BankNifty future (5547) is only at marginal premium to the spot 5545. Bankshares continue to look bullish following a big jump on Friday when heavyweights like SBI, BoB and PNB rose on high volumes.

It would be a reasonable projection to expect that the Banknifty will continue to climb so a naked long November future is possible.

Since individual stock futures in high-weight banks are also possible, you would have to weigh the margins and your individual needs carefully. I'd advise staying out of the CNXIT for a while until liquidity gets better and a clear trend develops in trading patterns. The index is technically mildly bullish but the future is illiquid and it may not retain that much premium over spot.

In the index options segment, there has been a vast expansion in November open interest in the only session of the settlement. The put-call ratio is well over 1 suggesting that the options market remains oversold.

This is normal when coupled to a rising spot market "� hedgers go long in spot or in individual stock futures and lay off the positions with puts against the Nifty. A high PCR does suggest that an instantaneous crash is unlikely although we could expect the correction to be quite powerful as and when it does occur.

When it comes to options spreads, there isn't any liquidity above the 3800 level so our strategies are necessarily constrained. A normal bullspread with long 3750c (82) versus a short 3800c (52.2) is expensive. You pay 30 for a maximum return of 20. This adverse risk:reward ratio means that you should avoid this until and unless the 3750c drops in price or more likely, the 3800c rises in price.

In terms of bearspread, there appear to be marked distortions. The relevant options are 3900p (105), the 3750p (85) and the 3700p (71). The spot Nifty is at 3739, which means that two of these are already in the money.

A long 3750p and short 3700p costs just 14 and pays a maximum of 36. What's more, it's just 3-4 points out of the money at this instant. The differential between the 3800p and the 3750p is far too low as well. A long 3700p (71) versus short 3650p (55) costs 16 and pays a maximum of 34.

The prices along the put option chain would undoubtedly change in the first hour of trading this week. But if the risk:reward ratios remain anything like as favourable, it would make sense to sit on a bearspread despite the apparent bullishness of the moment. If the market breaks anytime before November 30, the bearspread will earn a handsome return.

STOCK FUTURES/OPTIONS

There's been quite a lot of action in the stock F&O section. This is not surprising given that it's still results season. The trend last week saw a lot of bullishness in banks.

Most banks are available in the stock futures segment and there has been large volume expansions.

My picks at the moment for short-term outperformance would include SBI, PNB, BoB and Canara Bank. It's an open question whether to buy a long BankNifty position or to buy individual stock futures in the banking sector.

My feeling is that a "portfolio" of these four banks would collectively outperform the BankNifty itself in the timeframe of the next 5-10 sessions.

Among other individual stock futures, Suzlon and GE Shipping seem quite interesting. Both futures have jumped in OI and overall volumes. Suzlon is taking a hammering after the market was apparently disappointed by the Q2 results.

GE Shipping is seeing a rise in investment and speculative action. Bharti is also on the verge of an upside breakout. Bharti and GE would be potential long positions.

The Suzlon future (1306) is now trading at premium to spot (1298) but there's a clear downward trend. Hind Lever is another stock that has seen selling.

It may be worth a short position with something like a long 220p (3.80) and short 210p (1.50) assuming that you can get the second position where OI is only about 6000. This bearspread would gain a maximum of 7.5 which is not bad since you pay about 2.5 for the position.