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| Bull spreads using calls are likely to be quite expensive if the market opens strong
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| Next week promises high volatility and uncertain direction for the market. The Nifty put-call ratio is around 0.36 -- overbought but not critically so. The market surged past another important resistance in Friday's session.
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| The short-term trend looks bullish but there are enough negative indicators to suggest that there will be pullbacks sometime during the week.
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| The Nifty could rise till around 1250 from current levels of 1222 before encountering significant resistance. On the downside, it could drop till 1165-1170 levels before finding strong support.
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| So 1170-1250 would be our primary range of interest. If a intermediate trend reversal starts, the Nifty could fall to around 1150 inside next week.
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| The August future is at 1216 and September is at 1215.55. This level of backwardation appears normal in a strong bull-run. Possible hedges and calendar spreads exist. Typically, a position of buy August and sell September would guard against the market reversing into bearish mode.
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| More interesting for the trader is the pricing of August Nifty options close to the money. The option call chain is 1170c (premium 52), 1180c (44.5), 1190c (38.65), 1200c (30.9), 1210c (25.20) and 1220c (20.4).
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| There is no liquidity above 1220. The implication is that near money call premiums will rise since there is a clear arbitrage profit at current spot levels with positions such as Buy 1200c and Sell 1220c. Out of money calls will also become available above 1220.
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| The put option chain is 1220p (26), 1210p(20.6), 1200p(16.1), 1190p (12.85), 1180p (10.15) and 1170p (7.5). Once again, there is no liquidity above 1220. The chances are that, if the market remains bullish, put premiums will decline.
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| So next week, we could pick up cheap bear spreads using normal method with puts. Buy higher strike put and sell lower-strike puts. Bull spreads using calls are likely to be quite expensive if the market opens strong and we have problems with creating a conventional bull spread because there isn't enough liquidity in calls above 1220. If we want bull-spreads, we could try to create them through puts. This is by selling high-strike puts and buying low-strike puts.
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| Let's look at straddles and strangles. At 1220 a put+call position costs 46.4. Although we expect the call premium to rise and the put premium to decline, we can use this as a benchmark.
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| This comes into profit outside 1174-1266, just about covering our expected range of movement. We can't use a conventional straddle because there are no out-of money calls available.
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| The lack of liquidity and the pricing imperfections thus make it very difficult to trade the market using sophisticated positions. The best option for bear-spreads is to buy 1210p + Sell 1190p for a potential return of 12 on an outlay of 8. For bull-spreads, the best option is sell 1220p+buy 1200p for a premium inflow of 10 and a potential loss of 10.
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| A trader could take either of these positions according to view or movements on Monday in premiums. The combined position is sell 1220p+buy 1210p +buy 1200p+ sell 1190p with a total inflow of 2. This is a bull spread close to money, with a bear spread further away.
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| If the market stays above 1220, the profit is around 2. If the market drops below 1195, the position will also yield a profit of around 2. It will lose a maximum of 7.8 if the market is stuck between 1195-1215. This combination could thus work if the trader is confident of a big swing in price or bullishness.
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| Stock positions: The F&O stocks that showed bullishness included BPCL, ONGC, Bhel, Reliance, Reliance Energy, Cipla, Dr Reddy's, Digital, Grasim, Tata Motors, Tisco, VSNL and Wipro. August futures are worth buying in each of these.
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| Bull spreads in Bhel are quite cheap. It is possible to combine long 290c(13.4) +short 300c (8.50) or short 310c(4.15). These bull spreads would respectively cost 5 with a potential profit of 5 and 9 with a potential profit of 11.
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| Similarly, the call chain in Reliance Energy (BSES) is quite interesting. It is possible to take bull-spreads using 300c (18.3), 310c (13),320c (7.70).
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| The call chain in BPCL between 280c (10.95), 290c (6.85) and 300c (4.15) is interesting because the stock is around 283 with a fair possibility of moving to the 290-295 zone. Bull spreads can be created by buying 280c and selling a higher strike.
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| Dr Reddy is climbing back up after a sharp decline. Spot is 1055 with a possibility of a move until 1100. Calls are quite high-priced and there are odd areas of illiquidities in the chain.
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| Take a out of money position such as 1070c versus 1110c if it becomes available. Grasim offers a bull-spread with buy 580c (24.5)+ sell 600C (18.1) where an outlay of 6 could fetch 14.
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| Digital and Wipro look quite bullish after Friday's session. Both are worth buying in the futures segment. Digital is at 477 and likely to be faced with selling around 495.
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| Wipro is at 961 with a chance of rising until resistance at 1000. Take positions accordingly -- both are liquid enough in the options segment.
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| Infosys seems to have turned bearish this week. It came back down to 3500 levels after hitting 3800 in the previous week. It has support here but the immediate direction is not clear. Close previous positions and wait for a clearer trend. |
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