| The derivatives market is likely to be hit by major loss of liquidity after the turnover tax comes into force.
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| However, that won't happen until the Finance Bill is actually passed and notified so we can ignore this provision for the moment and pretend that nothing has changed in terms of this settlement.
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| The Budget has failed to impart a clear sense of direction to the market. We can see two possibilities inside this settlement. The market may rise slightly, moving from current Nifty 1553 levels till around the 1600 level. It might remain range-bound, between 1500 and 1580. The latter case includes the possibility of a slight fall.
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| The futures market continues to show backwardation. July Nifty is around 1537, August Nifty is at 1527 and September Nifty is at 1525. Open interest (OI) is dramatically lower for August and September. A possible exploitation of this backwardation is to sell July and buy August hoping to cash in as and when, the 10-basis-point difference narrows.
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| By and large, that pattern of backwardation is reflected across most stocks in the F&O segment. This offers the possibility of arbitrage for those who hold long-term portfolios. They can sell their stocks and buy the July future from the market, thus trying to lock in a small gain.
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| The general backwardation implies that the market expectation is that of further declines. But the Nifty put-call ratio is also high, at above 0.65 and this suggests that the market is fairly oversold and this factor could fuel a rise.
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| Implied volatility (IV) seems high with close-to-money (CTM) option premiums fairly expensive. Since we don;'t expect massive volatility or large moves, it may be possible to create positions selling options in such a situation.
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| The Nifty call-premium chain is such that small, CTM, bull spreads may not be very profitable. For example, consider the range 1550c (40.5), 1560c (36), 1570c (30.5), 1580c (24.65), 1590c (21) and 1600c (19.5).
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| Obviously a long 1560c versus a short 1570c costs around 5.5 and it could pay a maximum of 4.5. That risk-reward ratio is not very good. Ratios improve at the 1580 level; a long 1580c versus short 1600c costs 5 and it could pay a maximum of 15.
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| The Nifty put-premium chain is as follows: 1550p (53), 1540p (49.5), 1530p (45.5), 1520p (40), 1510p (36) and 1500p (31.5). Oddly enough, a classic bear-spread CTM of long 1550p versus short 1540p costs 3.5 and could pay 6.5. The ratios don't get better any further from the money. The OI position doesn't suggest any massive imperfections that could account for this.
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| So, strictly in terms of risk-reward ratios, the market seems to favour bull-spreads far-from money and bear-spreads close-to-money! What about straddles and strangles? In a situation where the market could move a moderate amount in either direction, we have ideal instruments in these two-way spreads. Also the high premiums CTM make short positions more attractive.
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| If we buy a straddle at 1550 with long 1550c and long 1550p, the position costs 93.5. It will be profitable only if the market moves outside the range of 1460-1640, which seems unlikely given the current technical position.
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| We could thus sell this position and cover with a long 1600c and long 1500p, which costs about 51. That yields an initial premium of 42 and offers insurance against a big move. The profit function is positive between 1510-1590, and losses are restricted to a maximum of 7.5.
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| Actually we can improve on this combined position. A short strangle involving short 1570c and short 1530p can be set off against the same long strangle of long 1600c and long 1500p. The initial yield is lower although the function is profitable across the same range of 1510-1590. But because the strangle profit function is less "spiky", it gives higher profits further from money. Also, the losses are restricted to a maximum of 5.
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| There are some reasonable stock picks in the F&O segment. Among PSUs, stocks such as Bharat Electronics, BPCL, Bhel and Shipping Corporation all look to be worth picking up in July futures. Arvind Mills, ITC, L&T, M&M, Maruti and Telco also seem to be decent punts in terms of long July futures. Hindalco seems to be a reasonable short.
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| In the options segment, liquidity is less easily available in these target stocks. A long 540c in Bhel is a possibility at a premium of about 14. You may be able to lay this position off with a short 560c at 10 with a outlay of 4 and potential profits of upto 16. The stock has been showing some volatility so be careful.
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| SCI offers a reasonably-priced bull-spread in the options segment. Buy a long 115c at 6.75 and sell a short 125c at 3. The position costs 3.75 and it could pay a maximum of 6.25, which is good enough.
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| The best of the stock option plays seems to be M&M. The stocks looked quite bullish at Friday's close of 510. Buy a long 510c (21.25) and sell a short 540c (11). This involves an outlay of 10.25 and it could pay a maximum of 19.75.
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| Telco seems to also offer good risk-reward ratios - a long 420c (13.25) versus short 440c (6) costs 7.25 and pays a maximum of 12.75. Among auto stocks, MUL also seems bullish but the option risk-reward ratios are somewhat less useful. A long 440c (13) versus short 460c (5) costs 8 and pays a maximum of 12. |
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