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B. Venkatesh

THE following strategies on HLL and Digital GlobalSoft are based on Monday's trading in the derivatives segment at the NSE.

Both stocks have moved up in recent times, and are poised for further price rise. The downside price projection is, however, farther away from the current levels than the upside price projection. This makes it worthwhile to construct a strategy that will take advantage of low-likelihood high-payoff downside event.

Equity options:

HLL: The downside price projection is Rs 159, while the upside price projection is Rs 181. Consider buying the December 160 puts, as they are cheaper in terms of implied volatility. The puts do not, however, carry theoretical edge, as the forecast volatility is lower than the implied volatility.

The directional risk is low, as the option is out-of-the-money (OTM). The vega risk is low despite the lack of margin of error in forecasting volatility. The loss in option value due to passage of time (theta) is also low, but so is the gamma. The implication is that theta-gamma is moderate, which means that the puts will not rapidly lose value, even if the stock declines slowly.

The December 160 puts will generate three-fold returns if the stock declines to Rs 159. The puts will lose its entire value if the stock drifts upward to Rs 181.

Since the put premium is very low, it is worth taking the risk. Do not hold the position for more than 12 days. The market lot is 1,000 options per contract.

Digital GlobalSoft: The downside price projection is Rs 565, and the upside projection is Rs 648.

Consider buying the December 600 puts, as they are cheaper in terms of implied volatility. The 600 puts carry some theoretical edge, which also provide margin of error for forecasting volatility.

The directional risk is low, as the option is OTM; the option delta is 33, which means that the puts will approximately decline (increase) a third for every point rise (decline) in the stock price. The benefit from long gamma is minimal. This coupled with moderate theta makes the theta-gamma trade-off rather stiff. The implication is that the puts will rapidly lose value unless the stock declines quickly.

If the stock declines to Rs 565, the 600 puts will generate 156 per cent returns. The puts will lose 34 per cent if the stock rises to Rs 648.

Note that the payoff are attractive for two reasons: one, forecast volatility is higher than the current implied volatility, and two, the upside projection point is close to the current level than the downside projection level. Even if one factor does not materialise, the payoff will be less attractive.

Do not hold the long puts for more than 16 days. The market lot is 400 options per contract.

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