Financial Daily from THE HINDU group of publications
Saturday, Mar 08, 2003
Financial Daily from THE HINDU group of publications Saturday, Mar 08, 2003 |
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Markets
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Derivatives Markets Columns - On the hedge Tata Steel: Outlook negative, buy March 140 puts B. Venkatesh
THE following strategies are based on Friday's trading in the derivatives segment on the NSE: Equity options Tata Steel: The outlook on this stock is negative. The near-term downside price target is Rs 128. The risk is that bottom-fishing may push the stock up to Rs 150. Consider buying the March 140 puts, as they are cheaper in terms of implied volatility. The puts are trading marginally above their theoretical value. The put premium will fall sharply for every point rise in the stock price. This is because the option delta is high, as the puts are in-the-money (ITM). This risk will only increase as the puts near expiration. The puts are, however, not subject to high risk due to fall in volatility. Note, however, that the puts will rapidly lose value if the stock does not reach the downside price target at the end of the trading horizon. The reason is that the puts will then have only 5 days to maturity; the option theta will be very high, eroding the put value. If the stock declines to Rs 128 at the end of the trading horizon, the March 140 puts will generate a maximum return of 185 per cent. If the stock rises to Rs 150, the puts will tend towards zero. The payoff is based on forecast volatility, which is lower than the current implied volatility. The reason is that the forecast volatility is based on the stock's recent historical volatility, which is low; typically, vols is low when the stock trends in either direction. If the realised volatility is higher than the forecast volatility, the payoffs will be better. The target trading-horizon is 14 days. The market lot is 1,800. HLL: The outlook on this stock is negative. This provides an opportunity to buy the farther month calls cheap. If you can afford the risk, buy the April 170 calls. The upside price target for the trading-horizon is Rs 180. The risk is that the stock may decline further to Rs 148. The call premium will not fall sharply for every point decline in the stock price. This is because the option delta is low, as the calls are out-of-the (OTM) money. The option delta is unlikely to change sharply due to passage of time. This is because the contracts are enough time to maturity. The calls are, however, subject to moderate degree of risk due to fall in volatility. It is important to note that the put-call ratio is low, as is the ratio of the open-position to the market-wide limit. These two factors suggest that the market has taken a very negative outlook on the stock yet. If the stock rises to Rs 180 by the end of the trading horizon, the April 170 calls will generate 98 per cent. The calls will, however, tend towards zero if the stock declines to Rs 148. The target trading-horizon is 27 days. The market lot is 1,000.
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