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Satyam: Outlook negative; buy December 260 puts

B. Venkatesh

THE following strategies are based on Tuesday's trading in the derivatives segment at the NSE:

Satyam Computer: The outlook on this stock appears negative. Two strong factors in this direction are the increasing put implied-volatility and put-call open interest ratio. The downside projection level is Rs 255, while the upside projection level is Rs 292.

Consider buying the December 260 puts, as they are cheaper in terms of implied volatility. The puts carry marginal theoretical edge, but enough to enjoy a decent margin of error for forecasting volatility.

The directional risk is moderate, as the puts are deep out-of-the-money (OTM). The benefit from long gamma is marginal. This coupled with moderate theta, the loss in option value due to passage of time, increases the theta-gamma trade-off. The implication is that the puts will rapidly lose value, unless the stock's downside drift is speedy. The vega risk is low, suggesting that the long put position will not affected much even if the volatility falls.

The December 260 puts will generate 177 per cent returns if the stock declines to Rs 255. The puts will lose 66 per cent if the stock rises to Rs 292.

Do not hold this position for more than 19 days. The market lot is 1,200 options per contract.

Index options: The outlook on index remains positive, though the uptrend may not be secular. The upside projection is 1085, while the downside projection is 1022.

Consider constructing a bull call-spread by buying the December 1060 calls and writing the December 1080 calls. This strategy will lower your initial outlay, but will also reduce trading profits. If you can afford a high outlay, construct a long 1060 call-position.

The directional risk of spread position is low, as is the loss in option value due to passage of time (theta). The spread position is gamma-neutral, which means that the short gamma cancels the long gamma value. The implication is that the spread position will not enjoy a lower fall in value when the spot index declines, and will not gather speed on the upside when the index rises (the gamma is akin to the convexity advantage that bonds enjoy). The vega risk is low, as is the theta-gamma trade-off.

The spread position will generate 74 per cent returns if the spot index rises to 1085. The call spread will lose 76 per cent if the index declines to 1022.

The position is highly risky, especially because of the margin requirement for the short-leg of the spread position. The payoffs for the long 1060 calls are 105 per cent returns and 83 per cent losses.

The target trading-horizon is 22 days, which coincides with the expiry of the contract on December 26. The market lot is 200 options per contract.

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