In-the-money calls in demand

B. Venkatesh

As a consequence of the rise in Nifty to 1035 points during the previous week, demand for index options shifted from November 980 strike to 1000, 1020 and 1040 strikes.

Here are some of the pointers from the week's trading:

Index options:

Despite the upmove in the spot market, demand was primarily concentrated on the in-the-money calls. This suggests that the dealers were nervous about the market rally; otherwise, they would have demanded more out-of-the-money calls, which are cheaper.

The November 1000 calls closed Thursday at Rs 34.95. The open interest in the calls stands at 1695 contracts. The calls are currently in-the-money by 36 points and the break-even for the call-buyer is 1035. A low put-call ratio of 0.31 favors the calls. With the November 1000 calls currently deep in-the-money and with only 4 days for expiration, the gamma of the option is very low. This means that dealers cannot profit much from the movement in option premium due to the upward movement in the spot index in the next 4 days.

The November 1020 calls closed Thursday at Rs 21.35. The open interest in the calls is now at 1151 contracts. The 1020 calls are currently in-the-money by 16 points. The put-call ratio in the 1020 strike is lower than in the 1000 strike, which suggests that the market may not fall below 1020 levels in the next 4 days. This can be corroborated with the probability of the put ending in-the-money, which is just half that of the call ending in-the-money. The spot index has to fall by 3 per cent to 1005 within the next 4 days for the put-buyer to profit from his or her position.

The November 1040 calls were the only out-of-the-money calls traded on Thursday. The calls closed Rs 10.45, and the open interest stands at 485 contracts. The 1040 puts, which are in-the-money by 4 points, closed at Rs 23.65. The puts are highly overpriced based on an option valuation model. Dealers who are willing to assume some risk may do well to bet on the 1040 calls; the higher gamma points will enable the dealers to somewhat profit from upmove in the spot index.

In the December contract, there was some demand for calls and puts in 960, 1000 and 1040 strikes.

Single-stock options:

In this segment, Satyam, Digital Globalsoft, Reliance Industries, Sterlite and L&T were actively traded during the previous week. As with index options, dealers were primarily demanding in-the-money calls.

The November 160 calls on Satyam closed Thursday at Rs 18.70. The option is currently in-the-money by 17.5 points. Though the probability of the option ending in-the-money is very high, dealers may need to consider the loss in option premium due to time-decay. With only 13 days to expiration, buyers of the 160 calls may loose about 5 points in option premium, while buyers of the 170 calls will loose only 3 points.

The November 260 calls on Reliance closed at Rs 19.55, while the puts closed at Rs 2. A low put-call ratio suggests that dealers expect the stock to stay above the Rs 260 in the spot market.

The November Sterlite 130 calls closed Rs 18.05, while the 140 calls closed at Rs 11.65. The 130 and 140 calls are currently in-the-money by 16 points and 6 points respectively. While the 130 calls are more likely to expire in-the-money, the gamma points favor the 140 calls.

In all, demand for in-the-money index and equity calls suggest not-so-bullish outlook on the market. Another point: those wanting to buy puts to bet on the downside need be aware that puts are generally overpriced in the market relative to the calls.