The Hindu Business Line : Negative outlook on Satyam, Tata Steel

Satyam: The outlook on the stock appears negative. The immediate price projection on the downside is Rs 225, and that on the upside is Rs 247. Do not be alarmed that the upside is placed at a higher level than the downside. The important point is that the likelihood of downside is higher. Consider shorting (selling) the September futures on the stock. Since futures moves at a similar speed to the spot market, your profit points will be higher if the downside price projection is achieved. Note, however, that loss will also be higher if the stock moves up instead.

You can hedge your risk by buying the September 240 calls. These calls are the cheapest in terms of implied volatility. The upside that you will gain from the option price movement is moderate, as the option delta is 40. Note, however, that the calls do not carry any theoretical edge, as they are trading rich. You will generate 60 per cent return if the stock reaches its downside projection level. Your losses will be very high if the stock moves up. The long calls will only moderate your losses, but will not protect the combination from incurring losses. Initiate the position if you can afford the risk.

Tata Steel:

The outlook on the stock appears negative. Consider buying the September 120 puts, which are the cheapest in terms of implied vols. Note, however, that the puts do not carry any theoretical edge, as they are trading rich. A good strategy would be to implement put bear spread, which involves buying the higher strike put, and writing (selling) a lower strike put. The problem, however, is that the lower strike put is currently out-of-the-money and hence carries low premium points. It, therefore, does not make economic sense to take exposure to negative convexity (writing options gives the seller higher risk and lower return).

The 120 puts carry high directional risk, as the option delta is 58. This means that a one-point decline (rise) in the stock price will approximately result in a 0.58 point rise (fall) in the put value. The trade-off between theta and gamma is also low, which means that the puts will not lose much value even if the stock sits still or moves down slowly.

If the stock touches the downside price projection of Rs 116, the 120 puts will generate 87 per cent returns. If the stock moves to its upside price projection of Rs 131, the puts will tend towards zero. The payoff is, therefore, skewed towards losses. The point, however, is that the likelihood of the stock touching the downside is currently higher.

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Negative outlook on Satyam, Tata Steel

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