The Hindu Business Line : Tata Steel: Outlook positive, buy Oct 250 calls

Tata Steel: The outlook on this stock is positive. The upside price target is Rs 290. The downside risk level is Rs 235. Note that the open interest position as a percentage of the market-wide limit is above 90 per cent. This has led to doubling of margins on futures and short option positions.

Consider buying the October 250 calls. The options are trading-rich, perhaps, displaying the high underlying volatility of the stock. The directional risk is high, as the calls are in-the-money. The primary risk is the high time decay.

If the stock rises to Rs 290 at the horizon, the October 250 calls will generate 70 per cent returns. If the stock declines to Rs 235, the calls will lose 87 per cent. The payoffs are based on forecast volatility, which is far lower than the current implied volatility. Should the stock dip initially and then rebound, the underlying volatility will increase, which will translate into higher realised volatility at the horizon. The time horizon is 24 days. The market lot is 1,800.

Infosys: The outlook on this stock is positive. The upside price target is Rs 4,640. The downside risk level is Rs 4,000. Consider buying the October futures instead of calls. The reason is that options on Infosys carry high time decay and vega risk. The implication is that the calls will rapidly lose value even if the stock trades at the current level for a couple of days and/or volatility declines.

At the current level, the long futures position will be exposed to 280-point downside. This risk cannot be hedged with puts because the farther month options are not traded yet. The position has to be initiated with strict stop-loss limits.

If the stock rises to Rs 4,640 at the horizon, the October futures will generate 360 points per unit (100 units per contract). If the stock declines to Rs 4,000, the futures position will lose 280 points per unit. The trading horizon is 22 days.

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