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Tata Power: Buy February 400 calls

B. Venkatesh

THE following strategies are based on Thursday's trading in the spot and the derivatives segments on the NSE:

Tata Power: The stock closed at Rs 388 in the spot market. The outlook could turn positive if the stock gaps up on Friday. The stock's high on Thursday was Rs 397. The stock's upside price target is Rs 412.

Consider buying the February 400 calls. The option traded for 10 points on Thursday. The position allows for 15 per cent error in forecasting volatility. This lowers the option's vega risk.

The primary risk, however, is the time decay. The reason is that the option strike including the premium cost is not far away from the price target.

The implication is that the payoff depends on how fast the stock accelerates to the upside price target. The minimum order size is 1,600. Traders who prefer to buy futures instead of calls should initiate the position only after the stock gaps up. Otherwise, the downside risk will be high. The margin on the long futures is approximately 25 per cent of the contract value.

PNB: The stock closed at Rs 274 in the spot market. The outlook could turn positive if the stock gaps up on Friday. In the event, the stock could touch Rs 311. The stock saw a high of Rs 282 on Thursday.

Consider buying the February futures if the stock gaps up on Friday. Initiate the position with sell stop at Rs 280. Thereafter, the position has to be traded with trailing sell stops.

Note that the downside risk cannot be hedged away with horizon-matching puts because options on the stock are not actively traded. The margin on the long futures is approximately 25 per cent of the contract value. The minimum order size is 1,200. The open interest position as a percentage of the market-wide limit is about 45 per cent.

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