Fill In The Gaps To Profit

The price gap between L&T's spot price and its near month futures provides an excellent arbitrage opportunity

The market remained bearish throughout the last week. The Nifty consolidated at around 1080 during the beginning of the week and from that level it came down to 1060 level at the end of the week. This is because both foreign institutional investors (FII) and domestic funds remained net seller during that period. On Friday the Nifty closed at 1059. Nifty future moved in tandem with the spot market leaving no room for any arbitrage opportunity. The near month Nifty closed at 1062 that day.

Despite a good result, Infosys remained weak mainly due to the falling US markets. As usual, Satyam Computers and Infosys were the most liquid counters in the derivative segment. The call and put options of Satyam witnessed transactions of Rs 17 crore and Rs 14 crore respectively, in terms of nominal value of contracts. While Nifty futures witnessed a volume of Rs 62 crore.

The near month future contracts of Larsen & Toubro(L&T) have been trading at a discount of around three per cent to the spot market throughout the week. It was a good arbitrage opportunity for investors holding the stock. By selling the shares and buying the future contracts one could earn around three per cent, less brokerage.

Considering this mis-pricing in the L&T counter, investors could attempt an arbitrage position using options and futures, which would yield an excellent return. We believe that the counter will continue with the mis-pricing for some time.

For the arbitrage position, sell the near month 170 call, buy the 170 put and buy the future and hold them till they expire. Going by the current price you can earn around Rs 4.5 per combination. That too risk free. So for 1000 contracts (trading lot) you can earn a guaranteed return of around Rs 4500, less brokerage. Don't forget to check your pay-off before investing. See the table for details.

A notable change in the market is that the premium has come down compared to last few months. Thanks to the reducing volatility. The volatility of the underlying is a factor of the option premium and the greek, which is used to measure the sensitivity of the option premium to the volatility is called 'vega'.

"Nothing is happening, except scams" lamented a Delhi based trader. We don't see a point for being bullish, if not bearish in the short term. Since the fate of the market will much depend upon the activities of FIIs, it can be safely assumed that the market will remain largely range bound. However, given the uncertainty, it is advisable to play safe and go for a short strangle by selling the near month Nifty 1040 put and 1080 call.

Go for a similar strategy in case of Satyam Computers, with the near month Satyam by selling 220 put and 260 call. Going by the current premium rate you can earn a maximum of around Rs 3 each pair. Thus for 1200 pairs, which is the trading lot, you can earn Rs 3600. We also advise the same strategy with the Infosys - go short with 3000 put and 3600 call. The maximum profit could be around Rs 32 each pair.