The market continues to fall partially due to pressure created by continuous arbitrage possibilities between the futures and spot markets. Next week, the Nifty could range between 2925-3250 and thedownside bias could continue until settlement (June 29).

Index strategies: Volumes and open interest have both increased in index instruments. So has the implied volatility. In the futures segment, the June Nifty is trading at 3061 points, July is at 3039 points, August Nifty is at 3018.55.

With the spot trading at 3091, the discounts are considerable. A calendar bear-spread with short June Nifty and long July Nifty should be quite profitable if it's held till close to settlement.

In the options market, the Nifty put-call ratio has dropped to around 0.65, which is incredibly low in the context of the past two years.

Classically this means that the market is overbought - there are too many calls outstanding and not enough puts. This implies further falls are possible. Our technical perspective is that the Nifty could range between 2925-3250 in the short-term and we could expect a pullback in the settlement week because the selling in the cash segment will be reversed.

In the options segment, both bullspreads and bearspreads would be profitable given the amount that the market is likely to swing. A wide bearspread such as a long 3000p (118) versus a short 2900p (82) would cost about 36 and pay 64. A less wide spread such as a long 3050p (139.7) and a short 2950p (101) costs 39 and pays 61.

This one looks good - it could be fully realised inside a single session and the risk: reward ratio is excellent. A normal bullspread of long 3150c (96) versus 3250c (59) costs 37 and pays 63. This is less likely to be fully realised at one go but it is a good risk: reward ratio and it's likely to be realised sometime during the settlement.

We wouldn't advise taking on straddles and strangles despite the likelihood of high volatility because of the rise in IV. Implied volatility is so high that you would have to realise both sides of a strangle to make money.

Of course that is possible but it seems an unnecessary risk given that normal bull and bear spread are offering decent risk:reward ratios. I would favour bearspreads slightly because of the low put-call ratio.

Among the other tradeable indices, the June BankNifty is trading at 4127.75 while the spot index is at a value of 4176.5. Unfortunately there isn't enough liquidity in the July series to consider calendar spreads. The discount on the future makes a long position tempting even though the technical position on the index appears to be bearish.

The CNX IT is trading at 3877 in the spot market while the June CNX IT futures are at 3857.45 and once again, there isn't enough liquidity in the July and august series to consider calendar trades. I would be more confident in advocating a long position in the CNXIT because the technical position and fundamentals are more in favour of a firm sector index.

With more than three weeks to go for settlement, there is a good chance that the position will pay.

Stock futures/ options

The arbitrage we were referring to comes into play in the sector. This is becoming so important it's worth explaining.

Assume a future is trading at a significant discount to the spot price and that an investor already owns the stock. This situation can be arbitraged with zero risk for a profit. Sell the stock and buy the future. Wait until settlement when the prices align.

At settlement, buy the stock andsell the future. You have locked in the differential and continue owning the stock. However the availability of this arbitrage creates downwards pressure on spot prices until the settlement, at which time the prices are likely to jump because of the buying.

Most stocks in the F&O segment are now trading at discounts on the June futures series. We could expect a continuous process of arbitrage until either the carry-differentials drop below the risk-free return or sentiment changes or settlement arrives. It's difficult to recommend trades on this basis since there is considerable intra-day volatility and the window of opportunity for arbitrage is generally short.

The best one can suggest is that you should keep a benchmark of 6.5-7 per cent annualised as the risk-free return. Allowing for slippages and execution error, this translates into a differential of 0.75 per cent or more nbetween futures and spot prices in a given counter.

A lot of stocks are offering that sort of difference. Tata Motors [Get Quote] and Maruti [Get Quote] for example, are trading at discounts of over 1 per cent in the futures market.

If you identify such stocks and miss the arbitrage opportunity, keep track of the potential offered by the reverse trade. Stocks that have been sold down over the settlement will firm up in the last week of settlement.

Again in general terms, a few unhedged long positions are possible given that some stocks seem to be bottoming out. Taking long futures positions across Hindustan Levers, HDFC [Get Quote], Dr Reddys, Ranbaxy [Get Quote] and Maruti could work.

Sensex Rise and Fall: Complete Coverage

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