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B. Venkatesh

THE following are some strategies based on Monday's trading in the derivatives segment at the NSE:

Equity options

Tata Steel: The outlook on this stock is negative. The downside price target is Rs 132, while the upside price target is Rs 143.

Consider buying the January 140 puts. The puts are priced at their theoretical value. Note that both price targets are close to the current spot price. Nevertheless, the puts will generate good returns because the option delta will increase when puts become deep in-the-money (ITM).

The directional risk is high, as the puts are just ITM. The benefit from the long gamma is not very high, but neither is the loss in option value due to passage of time (theta). The result is that the theta-gamma trade-off is not very high. The implication is that the puts will not rapidly lose value even if the stock's downside drift is slow. The vega risk is low, but the position is exposed to the volatility risk as the option does not provide any margin of error for forecasting volatility. This means that the volatility may fall, but if it does a low option vega ensures that the fall in put value is not high.

The January 140 puts will generate 70 per cent returns if the stock declines to Rs 132. The loss will be 34 per cent if the stock rises to Rs 143.

Do not hold the position for more than 15 days. The market lot is 1,800 options per contract.

MTNL: The outlook on the stock is negative, though the downside from the current level is limited. The downside price target is Rs 95, while the upside price target is Rs 108.

Consider buying the December 95 puts, are they are cheaper in terms of implied volatility. Like Tata Steel, the price targets on MTNL are also close to the current spot price of the stock. The puts are trading at higher than their theoretical value. This means that the position carries high volatility risk.

The direction risk is moderate, as the puts are out-of-the-money (OTM). The benefit from long gamma is marginal, but so is the loss in option value due to passage of time (theta). The position, hence, carries low theta-gamma trade-off. This suggests that the puts will not lose value even if the stock's downside drift is slow. The vega risk is very low, and hence, moderates the high volatility risk.

If the stock declines to Rs 95, the puts will generate 10-fold profits! This is because the put premium is very low. If the stock rises to Rs 108, the puts will lose their entire value.

The target trading-horizon coincides with the expiry of the December contract. The market lot is 1,600 options per contract.

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