Weekly Derivatives Perspective

The prolonged uncertainty over the possibility of armed conflict in Iraq finally got over this week. The subsequent events have generated a strong hope that the war would be rather short and one-sided, boosting sentiments globally. Strong global equity performance and a return by institutional players further propped up the sentiments. Sensex exhibited a strong performance during the week to close above the psychologically important level of 3200.

Derivative volumes during the week were on the higher side. Open interest declined, in general, except for stocks like Digital and Satyam where it increased. Positions were shifted from March to April contracts in a number of stocks including Reliance and SBI. The trend of declining positions in the futures segment and a corresponding increase in the options segment was visible this week as well. This is understandable in the context of uncertain geopolitical situation.

The cost of carry came down across the board for Nifty and stock futures. Backwardation was visible in Infosys, Digital and BHEL, presenting an arbitrage opportunity. The cost of carry declined for both - March and April futures. This clearly points towards the doubts that market players have regarding the sustainability of the present rally, improvements in the geopolitical environment notwithstanding. Another prominent observation during the week was the sharp decline in the implied volatility for options. This was particularly true for call options. The put-call ratio improved over the last week.

Markets have expectedly seen a good rally from oversold levels and are now placed just below crucial resistance level. For the Sensex, the level of 3220 will be very important. If it is able to cross this level, the rally may extend upto 3250 and then 3290. On the downside, the support levels would be 3170 and 3125. However, the present rally is still corrective in nature and investors should keep a tight vigil over their positions. The geopolitical situation might still spring up surprises in form of prolonging of the Iraq conflict. Investors may yet again opt for a straddle on Nifty, comprising a long 1050 call and a 1020 put. The 1025 level would yet again be an important for Nifty and may be used as the stop-loss level. Long positions in futures must be hedged through puts.

The present uncertain times offer a good opportunity to buy select calls. In spite of the last week's rally, many stocks still offer good value. Focus would now be primarily on options expiring in April, as by then the investment environment would certainly clear up. The fact that the implied volatility for most stock options is on the lower side further makes a case in this regard. The budget failed to fulfill the expectation of FII limit hike in SBI. However, this announcement may yet come. With fundamentals still intact, investors may buy April 300 call on the stock. Another stock that can see substantial event specific movement is HPCL. The current disappointment over the slow pace of divestment may give way to more cheerful sentiments as the divestment process gathers pace. Further, the recent decline in crude oil prices would also allay the fears that oil companies have not been able to price refined products at market linked prices. Investors may buy April 320 call on the stock.

The order book position of L & T has seen a good improvement, both in qualitative and quantitative terms, in recent weeks. The Grasim - L & T saga has also revived again and may result in a price trigger for the stock. Investors may buy 200 call on the stock. As there is not much downside for L & T beyond 180, investors may also consider writing 180 puts on the stock. There have been some concerns on the progress achieved by Reliance in its telecom services, because of which the markets have not fully discounted the strong performance in its petrochemicals and refining businesses. Any clarification on the same would mean a good rise for the stock. Investors may buy 300 call on the stock.

ITC declined during the week on rather thin volumes. As the fundamental business of the company remains strong, investors may utilise the decline to buy 630/660 calls on the stock. Investors may also look at writing covered calls on the stock. IT stocks saw a sharp improvement during the week. Investors may wait for a correction before entering these.

Investors looking to enter the markets at further lower levels may sell puts in ACC (135 put), BHEL (200 put), SBI (280 put) and Tisco (135 put).

*Contributed by -
Tarun Mathur
Escorts Securities Ltd.