The Hindu Business Line : SBI, Bank of India: Near-term outlook appears positive

Aggressive traders can buy May futures. The near-month contract trades on par with the spot price. Initiate the position with spot-market-stop-loss at Rs 500. The stop-loss is far away from the current price keeping in line with the high volatility on Friday. It will not be cost-effective to hedge the downside risk with horizon-matching calls.

The margin on the futures position is approximately 17 per cent of the contract value. The minimum order size is 500 units. An alternative strategy would be to construct a bull vertical spread. This can be initiated with the long May 500 calls and short May 540 calls. The spread can be set up for a net debit of 13 points. This position will be profitable even if the stock were to reach the upside price target of Rs 539 on option expiration. The reason is that the long call will be deep in-the-money while the short call will almost expire worthless.

The payoff will be, however, different if the stock were to reach the price target well before maturity. Note that the maximum loss on the spread position based on the current premium levels is lower than the stop-loss limit on the futures position.

Bank of India: The stock closed at Rs 57 in the spot market. The near-term outlook appears positive. The stock could move to Rs 66 and then to Rs 70. Buy May futures. The near-month contract trades on par with the spot price. Initiate the position with spot-market-stop-loss at Rs 55. A tight stop-loss is necessary to control the downside risk, as the contract-multiplier is 3,800 units. The margin on the futures position is approximately 26 per cent of the contract value.

The alternative strategy of initiating long option position might not be profitable. The reason is that the cheapest strike (in terms of implied volatility) plus the option premium is close to the price target. Even a bull vertical spread might not be optimal because the active out-of-the-money calls are not far away from the current spot price.

The implication is that these OTM calls are likely to attract higher implied volatility than the ITM calls. This exposes the spread position to high vega risk.

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