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B. Venkatesh

THE following strategies are based on Thursday's trading in the derivatives segment on the NSE:

Equity option: The outlook on SBI appears negative. The downside price target is Rs 260. The risk is that the stock may move to Rs 295 before declining to that level.

Consider buying the April 280 puts. The farther month contracts are not very liquid. You may, therefore, have to acquire the options at higher implied volatility. Do not pay more than Rs 8.50 per option.

The puts will fall moderately for every point rise in the stock price. This is because the put delta is moderate, as the puts are out-of-the-money (OTM). The puts will not fall sharply if volatility falls. The position is, however, subject to high risk if the stock does not decline to the downside price target by the end of the trading horizon.

If the stock declines to Rs 260 by the end of the trading horizon, the puts will generate a maximum gain of 110 per cent. If the stock stays at Rs 295 at the horizon, the puts will lose 80 per cent. Note that the payoffs are based on forecast volatility that is lower than the current implied volatility. The payoffs will be better if the realised volatility is higher than the forecast volatility. The trading horizon is 13 days. The market lot is 1,000.

Index option: The outlook on the spot Nifty index is negative. The downside target is 1000. The risk is that the current bout of buying interest may push the spot index to 1050.

Consider buying the April 1020 puts, as they are cheaper in terms of implied volatility. The puts are priced near their theoretical value, but do not provide any margin of error for forecasting volatility.

The puts will not fall rapidly for every point rise in the spot index. The reason is that the puts are OTM. The position is, however, subject to high vega and theta risk. The implication is that the puts will fall sharply if volatility falls. The position will also rapidly lose value if the spot index does not settle near 1000 at the end of the trading horizon.

If the spot index trades at 1000 at the trading horizon, the April 1020 puts will generate a maximum return of 160 per cent. The puts will lose 85 per cent if the spot index settles at 1050 at the trading horizon. The trading horizon is 20 days. The market lot is 200.

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