Traders ready F&O positions on banks

Ahead of today's Reserve Bank of India review, many hope for a 50-basis-point cut in key policy rates

Savvy traders have readied trading strategies involving banks ahead of the Reserve Bank of India’s (RBI) rate-setting meeting tomorrow. The positions have been created in stock futures of banks, which bet on a 50-basis point (bps) cut in the key policy rate, the repo, higher than the market’s expectation of 25 bps.

In this trade, a basket of private bank futures is sold and contracts of public sector banks (PSBs), mainly State Bank of India (SBI), are bought simultaneously. The strategy bets on a rally in PSB stocks and underperformance of their private peers if the repo rate is cut by 50 bps.

 

A higher-than-expected cut in the repo could trigger a rally in government securities, boosting bond portfolios’ values of PSBs and helping raise treasury income, said brokers. State-owned banks are the biggest buyers of government bonds, while private lenders usually stick to the minimum statutory requirements during bond purchases.

HOW IT WORKS

• A basket of private bank futures is sold and contracts of PSBs, mainly SBI, are bought simultaneously
   
• Positions are created in stock futures of banks, which bet on a 50-bps cut in the key policy rate, the repo, higher than the market's expectation of 25 bps
   
• The strategy bets on a rally in PSB stocks & underperformance of their pvt peers if repo rate is cut by 50 bps
   
• A higher-than-expected cut in the repo could trigger a rally in govt securities, boosting bond portfolios' values of PSBs and helping raise treasury income

“Any significant correction in bond yields (rally in prices) is likely to benefit PSBs more, due to a large proportion of trading book with relatively high duration. Historically, bond gains have been used to provide for bad assets and support earnings,” said Axis Capital’s analysts, led by Praveen Agarwal, in a note to clients.

Worries about deteriorating asset quality have resulted in PSB shares lagging those of private lenders in the past year or so. Since January 2012 to date, State Bank of India, the country’s largest bank, has gained 52 per cent; private lender ICICI Bank, the country’s second largest, has gained 71 per cent.

Analysts said a repo rate cut of just 25 bps could result in their bets going awry, as the trading strategy is relying on the central bank slashing rates by 50 bps. “For traders who think the rate cut could be 50 bps, it makes perfect sense to buy PSBs. Private sector banks have hardly fallen because of the short positions,” said Amit Gupta, head-derivatives of Mumbai-based ICICIdirect.

Analysts said there was a bias toward stocks with riskier prospects as these had not moved as much as the steady ones.

“Traders preferred quality names in the banking space in the early part of the rally. Now, there is a shift to the high-beta names as the rally enters the last lap,” said an institutional derivatives analyst with a domestic broker.

Analysts said if RBI refrains from cutting the repo rate at all, shares of leading lenders could see selling pressure.