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B. Venkatesh

THE following are some buy/sell strategies based on Wednesday's trading in the derivatives segment at the NSE:

Equity options

Ranbaxy Labs: The outlook on this stock appears negative. The price projection on the downside is Rs 875, while that on the upside is at Rs 950. Consider buying the September 900 puts, as they are cheaper than other puts on the stock in terms of implied vols. The puts do not carry any theoretical edge, as they are trading rich. This also means that there is no margin of error for forecasting volatility.

The 900 puts carry low directional risk, as the option delta is only 34. The price that you pay for buying the gamma is, however, very high; for the loss in option value due to time decay (theta) is high. Note also that the vega risk is also high, which suggests that the puts will rapidly lose if the vols falls.

If the stock moves down to Rs 875, the 900 puts will generate 250 per cent returns. If the stock, however, moves up to Rs 950, the puts will lose its value. Note that the puts will also lose value if the stock sits still or moves down slowly, as the option theta is very high. Do not hold the 900 puts for more than five days.

Reliance Industries: The immediate outlook on the stock appears negative. The very short-term downside price projection is Rs 249, while the very short-term upside price projection is Rs 272. If you are looking to trading for just 2 days, consider buying the September 260 puts. These puts, cheaper than other puts on the stock, do not carry any theoretical edge. The directional risk is high, as the option delta is 56. The trade-off between theta and gamma is moderate, but this need not be a cause for concern, as trading duration is just 2 days.

If the stock moves down to the price projection level of Rs 249, the 260 puts will generate 135 per cent returns. If the stock, however, moves up to Rs 272, the puts will tend towards zero. Initiate this position only if you can afford the risk. Note that you will have to buy minimum of 600 options to initiate the long put position.

Index options: The outlook on the spot index is negative. On the downside, the spot index could touch 951. The risk is that the spot index could also move up to 1017. Consider buying the October 970 puts. These puts are cheaper than other puts on Nifty. Note, however, that the puts are trading rich, and hence, do not carry any theoretical edge.

The directional risk is moderate, as the option delta is low. The vega risk is very high, which means that the puts will lose value if the vols falls. This risk is enhanced further, as the margin of error for forecasting vols is zero. The trade-off between theta and gamma is very high, which suggests that the puts will rapidly lose value unless the spot index moves down quickly.

If the spot index moves down to 951, the 970 puts will generate 77 per cent returns. If the spot index, however, moves up to 1017, the 970 puts will lose 83 per cent. The left skewed pay-off matrix notwithstanding, the likelihood of the spot index falling down is higher. This could make the long put position profitable. Initiate the position if you can afford the risk.

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