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Tata Steel: Outlook negative, buy February 440 puts

B. Venkatesh

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

Tata Steel: The stock closed at Rs 450 in the spot market. The outlook appears negative. The downside price target is Rs 440. If selling pressure continues, the stock could decline to Rs 428.

Consider buying the February 440 puts. The option is trading rich at 5.50 points. The position is, hence, subject to high risk due to change in the volatility of the underlying. The puts' primary risk is, however, the high theta effect because the option expires in just 7 days.

The option payoff depends on the stock's downside price acceleration. The sooner the stock reaches the price target, better the payoff. Note that the position will be profitable even if the stock declines to Rs 440 on option expiration.

Initiating short futures instead of long puts will be risky even if the position is traded with tight buy stops. The open interest position as a percentage of the market-wide limit is above 75 per cent. The minimum order size is 1,800.

Arvind Mills: The stock closed at Rs 50 in the spot market. The outlook appears negative. The downside price target is Rs 42.

Consider selling March futures on the stock. Initiate the position with sell stop at Rs 53. The position has to be traded with trailing buy stops. Note that the stop-loss limits should be tight. Otherwise, the risk-return trade-off will be skewed. The margin on the short futures position is approximately 55 per cent of the contract value. The open interest position as a percentage of the market-wide limit is about 80 per cent.

Traders willing to risk Rs 4,500 can consider buying the February 50 put instead of shorting futures. Note that the option is trading rich. This subjects the position to high volatility and theta risk. The option will payoff if the stock trades below Rs 47 on option expiration. The minimum order size is 4,300.

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