Financial Daily from THE HINDU group of publications
Friday, Dec 06, 2002
Columns - On the hedge
Nifty: Downside limited; construct bear put-spread
THE following strategies are based on Thursday's trading in the derivatives segment at the NSE:
Tata Engg: The outlook on the stock is positive, though the upside from the current level appears limited. The upside price projection is Rs 173, while the downside price projection is Rs 155.
Consider constructing a bull call-spread. This can be structured by buying the December 160 calls, and writing the December 180 calls. The position carries no theoretical edge, but provides some margin of error for forecasting volatility (vols). This is possible because the short-leg of the spread position carries higher implied vols than does the long-leg.
The directional risk of the spread is moderate, but the position does not enjoy any benefit of the gamma. This is because the spread is gamma neutral; the short gamma value cancelling out the long gamma value. The vega risk is minimal, which suggests that the spread will not rapidly lose value if the upside stock drift is slow.
The position will generate 49 per cent profits if the stock rises to Rs 173. The spread will, however, lose 54 per cent if the stock declines to Rs 155.
Note that the payoff based on the long 160 calls is less attractive. The reason is that the spread's initial outlay is lower due to the short call-leg. The payoffs do not consider margin requirement, which will further reduce the returns.
The position is highly risky. Do not hold the spread for more than 9 days. The market lot is 3,300 options per contract.
Index options: The outlook on the Nifty spot index is negative, though the downside from the current level appears limited. The downside projection level is 1025, while the upside projection level is 1060.
Consider constructing a bear put-spread. This can be initiated by buying the December 1060 puts and writing the December 1030 puts. The net theoretical edge is minimal.
The directional risk of the put spread is moderate, but the position does not derive any gamma benefit. This is because the spread is gamma-neutral. The vega risk is moderate. The position enjoys positive theta, which suggests that the spread can gain value due to the passage of time. This is possible because the theta of short-call is higher than that of the long-call.
The put spread will generate 65 per cent returns if the spot index declines to 1025. The position will lose 15 per cent if the index rises to 1060.
Note that the payoff on the long 1060 puts shows 80 per cent returns, and 25 per cent losses. Besides, the initial outlay will be higher. Do not hold the put spreads for more than 16 days. The market lot is 200 options per contract.
Do not initiate this position if you already hold bull call-spread, a strategy recommended on December 4.
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