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Saturday, Aug 10, 2002

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Positive outlook for L&T

B. Venkatesh

THE following are some buy/sell strategies based on Friday's trading in the derivatives segment at the NSE:

Equity options: The immediate outlook on Satyam appears positive. Buying calls to profit from the positive outlook may not be, however, worthwhile, as the upside appears limited. The stock may find resistance at Rs 208, and then at Rs 218. On the downside, the stock may find support at Rs 190, and can move down even further should the negative outlook consolidate. If you buy the August 200 calls, which are the cheapest in terms of implied volatility (vols), you can make a profit of 18 per cent if the stock moves to the first resistance level of Rs 208. You may, however, incur losses of around 70 per cent if the stock moves into first support level of Rs 190. Moreover, the trade-off between theta and gamma is very high. This means that your calls will lose more value due to passage of time (theta) than they will gain due to the positive gamma.

  • The immediate outlook on L&T appears positive. But it may not be worthwhile to buy calls on L&T, as the stock vols is very low. This means that the stock does not move up or down very sharply. This makes long calls or puts somewhat unattractive, as the option becomes less valuable when the stock vols is low. If you can take the risk, however, consider buying the August 160 calls, which are the cheapest in terms of implied vols. The calls can lose 82 per cent if the stock moves to its first support level of Rs 160. If the stock moves up to its resistance level of Rs 180, however, you can enjoy a 150 per cent profit on your calls. The positive factor is the high option delta of 0.73. This means that the calls will rise 0.73 point for every point rise in the stock price. The trade-off between the theta and gamma is also not very high, which is another positive for the long call position.

    Index options: The outlook on the spot index does not appear positive, despite the market ending higher on Friday. Refrain from buying calls, as the payoffs appear unattractive. If you buy the August 980 calls, which are the cheapest in terms of implied vols, the call value will tend towards zero if the spot index moves towards its support level of 930. Your calls will, of course, generate more than 150 per cent profit if the spot index moves towards 1,000. Note, however, that it may take a long while for the index to reach that level. Besides, you will incur losses if you hold the calls for a long while, without the spot index moving up considerably. The reason is that the loss in option value due to passage of time (theta) is very high compared to the gain due to the positive gamma.

  • The following should be read with the follow-up table: Sell the August 130 and 125 calls on Tata Engg if the stock crosses Rs 134.

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