The Hindu Business Line : HLL: Outlook negative, short May futures

HLL: The outlook on this stock is negative. The fact that the market is pricing the puts at a substantially higher premium than calls is an indicator in this direction. The downside price target is Rs 130. The risk is that momentum buying may push the stock to Rs 158, its first resistance level during the trading horizon. Consider shorting futures on the stock. At current level, you will be exposed to 10-point downside.

You cannot buy a cost-effective hedge to protect this risk. You can, however, buy May 160 calls to hedge the excess downside in the position. The calls will co-move with the spot if the stock inches above Rs 160. Since the calls will carry time value even at the trading horizon, the position will suffer maximum loss if the stock trades between Rs 150 and 160.

If the stock trades at Rs 130 at the trading horizon, the short futures long calls will generate a maximum gain of Rs 15,500 per contract. If the stock trends towards Rs 158, the position will lose Rs 3,750. The payoffs do not include margin requirement necessary for the short futures position. The trading horizon is 21 days. The market lot is 1,000.

Mastek: The outlook on this stock is negative. The downside price target is Rs 515. The risk is that the stock may first move to Rs 575 before declining to the downside price target. Consider buying the April 570 puts. Note that these are the only traded put contracts on the stock. Liquidity is a cause for concern if you propose to close the position during the trading horizon.

The position carries high directional risk for two reasons: First, the put delta is high, as the puts are in-the-money. Second, the trading horizon coincides with the maturity of the contract, and options exhibit high volatility as they near expiration.

The implication is that the put delta is subject to sharp change, and cannot be taken as a proxy for the directional risk. The position is also subject to high losses if the stock does not trend towards the downside price target at the trading horizon.

If the stock declines to Rs 515 at the trading horizon, the April 570 puts will generate a maximum return of 80 per cent. If the stock trends towards Rs 575, the puts will lose its entire value. Note that the payoff is not sensitive to puts' forecast volatility, as the trading horizon coincides with the expiration of the contract. The market lot is 400.

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