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Wednesday, Nov 27, 2002

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Infosys: Outlook negative, buy December 4600 puts

B. Venkatesh

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

Equity options: The outlook on Infosys appears negative. The downside projection is Rs 4295, while the upside projection is Rs 4710. Consider buying the December 4600 puts, which are cheapest in terms of implied vols. The puts are priced marginally above their theoretical value and hence do not carry any theoretical edge.

The directional risk is high, as the puts are in-the-money (ITM). The benefit from long gamma is very low. This coupled with high theta (the loss in option value due to passage of time) increases the theta-gamma trade-off. The implication is that the puts will rapidly lose value, unless the stock declines fast.

If the stock declines to Rs 4295, the December 4600 puts will generate 54 per cent returns. The puts will, however, lose 54 per cent if the stock rises to Rs 4710.

Note that the payoff will be less attractive if you buy the deep out-of-the-money December 4200 puts, which are the next cheapest in terms of implied volatility; the payoff matrix for this contract is 36 per cent returns, and 80 per cent losses. The 4600 long put position is highly risky. Do not hold this position for more than 23 days. The market lot is 100 options per contract.

Index options: The upside in the Nifty spot index is limited. The upside projection is 1048, while the downside projection is 1020. Consider constructing a bull call-spread by buying the December 1020 calls, and selling the December 1040 calls. The spread position carries theoretical edge because the long call-leg is priced at below its theoretical value, and the short call-leg, above its theoretical value.

The directional risk of the spread position is moderate. This also means that the position will not generate high profits. The position is gamma-neutral, which means that the long gamma value cancels with the short gamma value. The spread vega is positive, because the vega of the short-position is higher than that of the long position. The same reason accounts for a positive theta; this means that the position will gain from passage of time, based on the valuation model parameters.

The spread position will generate 67 per cent returns if the spot index rises to 1048. The position will lose 22 per cent if the spot index declines to 1020.

Do not hold this position for more than 10 days. The market lot is 200 options per contract.

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