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B. Venkatesh

THE following are some buy/sell strategies based on Tuesday's trading in the derivatives segment at the NSE:

Equity options

L&T: The outlook on the stock appears uncertain. The price projection on the upside is Rs 188.50, and that on the downside is Rs 157. The near-symmetrical projection from the current spot price is in line with the uncertain stock movement.

Construct a straddle to capture the likely movement on either side. You can buy the October 170 strike, as it is the cheapest available in terms of implied volatility (vols).

The directional risk of the straddle is high, as the calls are currently in-the-money (ITM). The vega risk is low, which moderates the loss due to error in forecasting vols. The loss in straddle value due to passage of time (theta) is also low.

If the stock moves up to Rs 188.50, the straddle will generate 143 per cent profits. If the stock moves to Rs 157, the position will generate 67 per cent profits. This does not in anyway signify sure-fire profits. If the stock trades in a range, the straddle will lose heavily. Do not hold the position for more than 13 days. The market lot is 1,000 options.

Dr. Reddy's: The outlook on this stock appears negative. The price projection on the downside is Rs 762.50. Consider buying the October 780 puts, as they are cheaper in terms of implied vols. The puts are nevertheless trading rich; at the current levels, the puts are 60 per cent more than their theoretical value.

The directional risk is low, as the options are OTM. The benefit due to long gamma is very low, which makes the theta-gamma trade-off very costly. The vega risk is also high, which means that the puts can lose value rapidly unless the stock moves down fast.

If the stock moves down to Rs 762.50, the puts will generate 37 per cent returns. If the stock, however, rises to Rs 826, the puts will lose 83 per cent. The left-skewed payoff matrix makes this long put position highly risky.

An option position in this stock has been recommended only to enable you to diversify your options trading portfolio. The diversification measure is not based on any correlation matrix between this option position and other recommended positions that are currently open.

Do not hold this position for more than 8 days. Note that the option contract on this stock is not liquid. The market lot is 400 options.

Index options: The outlook on the Nifty spot index is negative. The downside projection is 941, while the upside projection is 971.50.

Consider buying the October 950 puts, as they are cheaper in terms of implied vols. The puts are priced near their theoretical value. The directional risk is moderate, as the options are OTM. The vega risk is high, which means that the puts could rapidly lose value unless the spot index moves down fast. The theta-gamma trade-off is also very high.

If the spot index moves down to 941, the 950 puts will generate 105 per cent returns. The puts will lose 35 per cent if the index rises to 971.50. Note that the puts will also lose heavily if the index is boxed in a range. Do not hold this position for more than 8 days. The market lot is 200 options.

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