Financial Daily from THE HINDU group of publications
Friday, May 07, 2004
Columns - On the hedge
GAIL: Outlook positive, buy May futures
THE following strategies are based on Thursday's trading in the spot and the derivatives segments on the NSE.
GAIL: The stock closed at Rs 227 in the spot market. The outlook appears positive. The upside price target is Rs 245 but the stock may face some resistance at Rs 237.
Buy May futures. The near-month contract trades on par with the spot price. Initiate the position with spot-market-stop-loss at Rs 220. This exposes the position to 7-point downside risk. The position has to be traded with trailing stop-loss to control this risk.
Traders wanting to hold the position till the contract expiration can buy the May 220 puts as a hedge instead of applying stop-loss limits on futures. The margin on the long futures position is approximately 17 per cent of the contract value. The minimum order size is 1,500 units.
An alternative strategy would be to buy May 230 calls. The option trades for 10 points. The option will be profitable so long as the stock moves to the upside price target.
The least-best outcome will occur when the stock moves to the price target on option expiration; the position will then deliver a 5-point profit. Note that structuring vertical spreads (call spreads) may not be optimal because the out-of-the-money calls are not trading rich.
BHEL: The stock closed at Rs 579 in the spot market. The near-term outlook appears negative. The downside price target is Rs 550.
Sell May futures. The near-month contract trades at one-point premium to the spot price.
Initiate the position with spot-market-stop-loss at Rs 589. This exposes the position to an initial upside risk of 10 points. The position has to be traded with trailing stop-loss. Otherwise, the upside risk will be high because the contract - multiplier is 600 units. It is not optimal to hedge the position with horizon-matching calls.
The margin on the short futures position is approximately 19 per cent of the contract value. Traders who are long in the spot market can sell the May 600 calls. The premium inflow of 18 points can be used as a partial hedge for the spot position.
An alternative strategy of buying puts instead of selling futures is not available because options on the stock are not actively traded.
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