Financial Daily from THE HINDU group of publications
Tuesday, Dec 31, 2002
Financial Daily from THE HINDU group of publications Tuesday, Dec 31, 2002 |
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Markets
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Derivatives Markets Columns - On the hedge Construct January bull call-spread on Infosys, Nifty B. Venkatesh
THE following strategies are based on Monday's trading in the derivatives segment at the NSE: Equity option: The upside potential in Infosys is limited. The upside price target is Rs 4845, and the downside price target is Rs 4560. Note that the downside price target carries more points from the current level from the upside price target. The likelihood of the stock reaching the upside price target, however, appears higher. Consider constructing a bull call-spread. The position can be structured by buying the January 4600 calls, and selling the January 4800 calls. This position generates high profits when the stock trades between Rs 4600 and Rs 4800. Importantly, the position will not benefit if the stock drifts above Rs 4800. The position carries low directional risk. The spread is gamma-neutral, which means there is no benefit from gamma. This is because the gamma value of the short option cancels that of the long option. The position carries negative vega, which means that it will benefit if volatility falls. The theta-gamma trade-off is high, which exposes the position to high losses unless the stock's upside drift is achieved within the target trading-horizon. If the stock rises to Rs 4845, the spread position will generate 27 per cent profits. The position will lose 54 per cent if the stock declines to Rs 4560. Note that initiating a long call position, say, the January 4600 calls, is unattractive given the high initial outlay, and low upside points. The spread position is highly risky, more so because it attracts margin requirement. Do not hold this position for more than 20 days. The market lot is 100 options per contract. Index options: The upside on the Nifty spot index appears limited. The upside target is 1110, while the downside target is 1080. Consider constructing a bull call-spread on the Nifty. This position can be initiated by buying the January 1060 calls, and selling the January 1100 calls. There two reasons why 1060 calls have been recommended - one, there are the cheapest in terms of implied volatility, and two, the loss on the 1060 calls will be lower than that of the 1070 calls, the next cheapest calls. The direction risk of the spread position is low, as the net option delta is small. The position carries negative theta, which means that the spread will benefit due to passage of time, assuming that the stock price, and volatility remains at the current levels. The spread is gamma-neutral, and vega-negative. This means that the spread will not benefit from gamma, but will benefit if volatility drops from the current levels. If the Nifty spot index rises to 1110, the spread position will generate 37 per cent returns. The position will lose 12 per cent if the spot index drops to 1080. The position is risky. Do not hold this spread for more than 8 days. The market lot is 200 options per contract.
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