Financial Daily from THE HINDU group of publications
Wednesday, Apr 07, 2004
Columns - On the hedge
Buy April futures on Tata Steel
THE following strategies are based on Tuesday's trading in the spot and the derivatives segments on the NSE:
Tata Steel: The stock closed at Rs 397 in the spot market. The primary trend appears positive though the stock could first retrace some of its recent gains. The stock could find support at Rs 382. On the upside, it could move to Rs 415 and then to Rs 452.
Buy April futures when the stock declines to Rs 382. The near-month contract trades at 2-point premium to the spot price.
Initiate the futures position with spot-market-stop-loss at Rs 376. This exposes the position to 6-point downside risk.
The position has to be traded with trailing stop-loss to control downside risk. The minimum order size is 900 units.
Traders can buy April 380 calls instead of futures. The option currently trades for 27 points.
The primary risk is time decay. If the stock takes time to bounce back after retracing its recent gains, the option will lose value due to time decay.
The position will be profitable even if the stock moves to the upside price target on option expiration.
SBI: The stock closed at Rs 628 in the spot market. The outlook appears positive. The near-term price target is Rs 640.
Buy April futures. The near-month contract trades at 4-point premium to the spot price. Initiate the position with spot-market-stop-loss at Rs 617.
This exposes the position to 11-point downside risk. This risk cannot be cost-effectively hedged. The position has to be traded with tight stop-loss.
Otherwise, the downside risk will be high because the contract-multiplier is 500 units.
Initiating April long call position instead of long futures might not be optimal.
The reason is that the near-term price target is below the strike plus the option premium.
The implication is that the option will be profitable only if the stock moves to the price target in quick time. Otherwise, it will lose more value due to time decay than it will gain due to upside movement in the underlying.
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