Float hedging

ONGC futures are trading at a significant discount to the cash market

The ONGC stock, which is now open for offer for sale by the Indian government, is seeing increased activity in the futures and options market.

For instance, the number of contracts traded in the March series of the ONGC futures contract jumped over 130 per cent on Friday, when the issue opened for subscription.

But what's more important is that the futures traded at a significant discount to the price on the cash market. On an annualised basis, the premium was well over 20 per cent in intra-day trade.

For IPCL, in whose case the public offer is over but allotment is pending, the annualised premium is 70 per cent.

For investors holding these stocks, selling them on the cash market and going long in the futures market will be a very rewarding experience.

But what's the reason behind this differential? Derivatives analysts point out that savvy investors who have made applications in these offers have gone short in the futures market.

In the case of ONGC, an allotment even at the higher end of the band (Rs 750) would result in a neat profit since the current market price is around Rs 800.

Besides, there are traders who have obviously taken a call that the share price will decline after allotment, since floating stock will increase by a huge proportion. In IPCL's case, the offer period is over but futures continue to trade at a huge discount to the cash price.

This is because the allotment is still pending, due to which the short positions would obviously have been reversed.

In any case, both ONGC and IPCL are not very liquid counters in the derivatives segment, because of which the data on premium/discount could get skewed. As far as the broad market goes, the derivatives segment continues to throw up mixed signals.

On the one hand, both volumes and outstanding positions have been coming down, both of which are negative indicators. But on the positive side, the put-call ratio has come down considerably.

The implied volatility on option contracts have also been coming down, which essentially happens when traders do not pay a high premium to purchase a put option to hedge market risk.

While the Nifty has made strong gains this week, it's still at a distance from the highs of 1980 it has reached earlier in the year. Currently, according to signals from the derivatives market, there are no signs of crossing those levels.

The drag on Apollo Tyres

The rise in the share price of Apollo Tyres has not kept pace with the tremendous rise in the share prices of commercial vehicle players, Tata Motors and Ashok Leyland, in the past one year. One of the main reasons for this is that although volume growth had been strong, margins were under pressure because of rising rubber prices.

Rubber accounts for over 50 per cent of the total raw material cost, which turn accounts for 60 per cent of production cost.

But the company's move to increase product prices earlier this year will negate the impact of higher rubber prices to a large extent going forward.

In FY05, when the benefits of the price increase will be fully visible, analysts believe that margins could actually expand because of the low base of FY04 and a continued growth in volumes.

The increase in the commercial vehicle market over the past few years clearly augurs well for Apollo.

This is because it's a strong player in the replacement market, which accounts for a majority chunk of the tyre market. Thus, even if offtake in commercial vehicle sales were to slow down, tyre companies would continue to benefit from the lag effect.

In any case, the outlook for commercial vehicle sales continues to be strong with a big chunk of the work on the national road projects still pending. Further, the tie-up with Michelin will obviously help the company consolidate its position in the radial segment.

Despite the plethora of positives, the stock trades at around 7 times estimated one-year forward earnings, which simply reflects the commodity-like nature of the company's business.

With contributions from Mobis Philipose