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Friday, Aug 30, 2002

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Contrarian strategy on Infosys may pay

B. Venkatesh

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

Equity options:

  • Infosys: Put and call implied volatilities signal that the immediate outlook on Infosys is negative, despite the rise in spot price on Thursday. It may, however, pay to take a contrary view on the stock.

    Construct an aggressive bullish strategy by buying September futures on the stock. The futures contract will provide higher profit potential than long calls if the Infosys stock moves up. Of course, the loss is will be higher too if the stock moves down. You can consider hedging your long futures position by buying the September 3400 puts. Note that all puts on Infosys are trading rich in terms of implied vols. Do not buy the puts at the current price, as the acquisition cost will reduce the profits on the long futures position. You can consider buying the 3400 puts at a premium of 40 to 45 points. It, therefore, follows that you should not initiate your futures position, unless you are able to buy the puts at that price.

    Note also that the trade-off between theta and gamma is always high for options on Infosys. This means that the long puts will rapidly lose value if the stock sits still, moves up or moves down slowly.

    The price projection on the upside is Rs 3700, at which level, the combination will generate at least a 125-point profit. If the stock, however, moves down to its price projection of Rs 3250, the long futures-long put position will lose 145 points. Since the profit-loss payoff matrix is skewed towards losses, initiate the position only if you can take the risk and not otherwise.

    HPCL: The outlook on HPCL appears negative. Consider constructing a call bear spread. The reason a long put position is not preferred is that the puts are trading rich, and may therefore lose value unless the stock moves down rapidly. Note, however, that the risk associated with a call bear spread is high. You can construct this position by writing (selling) the September 260 in-the-money (ITM) calls, and buying the 280 calls. The advantage of writing ITM calls is the higher premium that you will receive and the directional advantage. Since the delta of the ITM call is higher, the 260 calls will lose more value (which is beneficial to the short position) for every point decline in the stock price. The 280 calls, on the other hand, will fall slowly because of its lower delta.

    The position will, however, lose money if the stock moves up.

    If the stock finds it difficult to cross the immediate support level of Rs 262, the bear spread will generate a profit of 3.3 points. If the stock moves to its second support level of Rs 245, profit points will increase to 8.58 points. If the stock, however, moves up to its resistance level of Rs 295, the bear call-spread will lose 9.45 points. Note that the risk is higher than the reward, though the likelihood of the stock moving up is lower than that it coming down. Initiate the position only if you can take the risk.

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