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B. Venkatesh

THE following strategies are based on Thursday's trading in the derivatives segment on the NSE:

Equity option:

The outlook on Ranbaxy is negative. The downside price target is Rs 860. The upside risk level is Rs 985. Consider shorting the October futures on the stock. The position will be exposed to 45-point risk. This risk cannot be cost-effectively hedged. The best available strategy would be to initiate the short position with strict stop-buy limits.

If the stock declines to Rs 860 at the horizon, the October short futures will generate 77 points per unit (800 units per contract). If the stock rises to Rs 985, the position will lose 45 points. Note that the high leverage will lead to heavy losses if the stock rises even marginally from the current level. The margin requirement is approximately 12 per cent of the contract value. The trading horizon is 12 days, but can be extended to 24 days.

Index option: The outlook on the Nifty spot index is negative. The downside target is 1255. The upside risk level is 1395. Given the possible trading width from the current level, an optimal strategy would be to initiate a long straddle/strangle on the index. The problem, however, is that implied volatilities are very high. This may impair the payoffs at the horizon.

Consider shorting the October futures on the stock, as the likelihood of the downside in the index is higher. At the current level, the position will be subject to 40-point risk. This risk cannot be cost-effectively hedged with Nifty calls; if strike lower than 1395 is used as hedge, the high cost of the call premium will cut into the profit points. The short position has to be initiated with strict stop-buy limits.

If the Nifty spot index declines to 1255 at the horizon, the October short futures will generate a maximum of 100 points per unit (200 units per contract). If the stock rises to 1395, the position will lose 40 points. The trading horizon is 14 days.

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