Both bullspread and bearspread look good

DERIVATIVES

They offer nice payoff ratios for positions which are liable to be hit quickly.

Two massive losing sessions sandwiched three smaller recoveries. Volumes were low although operator and retail presence was apparent. Volatility continues to be high. Next week might see a technical bounce.

Index strategies
Volumes and open interest are down roughly 50 per cent from last year's average levels. The FII contribution dropped last week because operators got into the act and there was some retail action as well.

FII contribution is still at a historically high level at about 42 per cent of open interest but it has fallen from 46-47. The MiniNifty saw a spurt in volumes which indicates retail interest.

Liquidity outside the Nifty was quite low and even other highly-tracked indices didn't see much action though underlyings were volatile. Most index futures ended the week very close to the closing values of the spot market.

The Nifty was highly traded and open interest (OI) expanded to healthy levels in April and May and to acceptable levels in June. The spot closed at 4,647 while the April, May and June contracts were settled at 4,652, 4,645 and 4,643 respectively. The MiniNifty was settled at 4,653, 4,649 and 4,649 with decent OI in all three months.

Other indices had no OI except in May and volumes and OI were generally low. The Junior closed at 7,774 and the futures was settled at 7,750. The Midcaps closed at 2,341 and it was settled at 2,350. The BankNifty was settled at 6,550 while spot closed at 6,545.15. The CNXIT closed at 3,801.6 while it was settled at 3,807.35.

Even in the Nifty itself, the differentials are insufficient to trade. There was short-covering in the last stages of Friday and nothing much can be read into the (negligible) premiums.

The Midcaps and the IT showed the most defensive strength in that they lost less than the broad market. Banks are likely to be very volatile since the RBI is widely expected to take action by hiking CRR. If it does, banks will fall further. If it doesn't, there'll be a relief rally.

In IT, the market will swing in a big way only after Infosys releases guidance for 2008-09. Unfortunately South seems to be the likelier long-term direction for the IT bellwethers but they could stay firm this week.

Technically speaking, the Nifty seems oversold and ready to bounce within a couple sessions. There is good support at 4,600 and lower down, at 4,500. An analysis of the put-call ratio in the Nifty options market suggests that the upside is also likely to come soon. The April PCR is at 1, which is neutral but the May-June PCR is above 2 and the overall PCR is at 1.13. There's been expansion across both puts and calls in all timeframes.

If we use the outstanding OI volumes in the chain as a proxy for support-resistance levels, it's evident that there's resistance above 4,900 and a lot of support at 4,500 because of the outstanding calls and puts respectively. There is more OI in the 5000c than in the 4900c "� the inversion suggests 5000 is a very strong barrier. Similarly there's more OI in the 4500p than in the 4600p

In this scenario, both puts and calls close to money appear under-priced.Calls are cheaper. Anything within 100-150 points could be struck within a single session and the payoff to risk ratios are good for both bullspreads and bearspreads.

A brave man may decide to sell reversed spreads outside the zone of 4,500-5,000 and try to collect the premium. These would be relatively high margin positions but there's a fair degree of safety if they are closed out within the next week.

The other tempting option is the wide strangle, gambling on the breakout. If this is laid off by a wider short strangle, it doesn't cost too much and it would work well in a breakout.

A close to money bullspread of long 4800c (88.85) and short 4900c (58.9) costs about 30 and pays a maximum of 70. A CTM bearspread of long 4600p (129.45) versus short 4500p (94.25) costs 35 and pays a maximum of 65. Both are very nice payoff ratios for positions which are liable to be hit quickly.

Even a combined position which is equivalent to a long strangle at 4600p, 4800c laid off by a short strangle at 4500p and 4900c is possible. This would cost 65 and offer a maximum return of 35 if the market moved to the limit in either direction or a total return of 65 if it moved both ways.

A wider strangle combination such as a long 4900c and long 4500p costs 154. This can be laid off with a short 4250p (35.5) and a short 5100c (23.8) lowering net cost to 95. In that case, a swing till 5100 or 4250 would fetch 105 and 155 respectively.

STOCK FUTURES/OPTIONS

Short-covering is the key possibility to be aware of and this makes it dangerous to stay short even in a falling market. Many stocks appeared to be generating short-covering late on Friday.

Real estate in particular and the Reliance and ADAG scrips would be most obvious targets. In banks, a CRR hike seems a likely dampener. If you choose IT stocks, go long in TCS, Wipro or Satyam rather than in Infy. The safest long positions would be in Ranbaxy and HUL.

Most intriguing would be a pair trade like long Mahindra and Mahindra (it's been bearish), short Hero Honda (it's been bullish). These two have been moving in opposite directions and the pair would gamble on the differential reverting to mean values.