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October 28, 2011

Strategy Payoff & Explanation Next move up

Stock view: State Bank of India (SBIN), after making a low of around Rs1,750, made a smart comeback in the October series. But the announcement of a 25 basis point rise in the repo rate and the deregulation of the savings bank deposits rate by the Reserve Bank of India (RBI) acted as a hurdle for SBIN due to its high current account-savings account (CASA) ratio. The rollover to the November series stands at 83% which is well above the average of the last three months (81.35%) and six months (79.18%) with a majority of the participation being on the long side. This is reflected in the rollover cost rising from 2 points to 15 points for the series. The volume weighted average price (VWAP) of SBIN for the October series stands at Rs1,858. The stock is trading well above this level with an addition in open interest (OI) and a rise in the cost of carry. The put to call ratio (PCR) has started the month at 0.37 with implied volatility (IV) hovering in the range of 37%-40%, indicating a positive bias for the counter. On the options front, the open interest addition is being seen in Rs1,850-1,900 strike puts while on the call side Rs2,000-2,050-2,100 are seeing a good addition. As per derivatives data, we feel the stock has surpassed the crucial level of Rs1,850-1,900 with a positive overall setup. Going forward, we may see higher targets of Rs2,050-2,100 for this counter. The recent low of Rs1,850 on a closing basis may act as a good intermediate support. Hence, to play this view we are forming a Ratio Bull Call Spread with a favorable risk:reward ratio. Ratio Bull Call Spread: A Ratio Bull Call Spread is created when the market/stock is expected to move in an upward direction. The Ratio
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Bull Call Spread is created by buying an at-the-money or a slightly out-of-money call (CE) and selling out-of-money CEs of two different strikes (refer table). It is a limited profit, unlimited loss strategy with a very favorable risk:reward ratio among the spreads. This can be constructed as follows:
Scrip SBIN CE 1950 SBIN CE 2000 SBIN CE 2100 Action Buy Sell Sell Formation Rate Quantity 63.55 43.65 20.3 250 250 250 0.4 Inflow

Strategy Note: The strategy has an initial inflow of 0.40 points in SBIN, which is Rs100 (0.40x250) and a maximum profit potential of 50.40 points, which is Rs12,600 (50.40x250). There are two break-even points for the strategy. The higher break-even point for the strategy is Rs2,150.40 and the lower break-even point is Rs1,950.00. If the stock closes between Rs2,000-2100 then the maximum profit of Rs12,600 can be earned. The total margin requirement to execute the above strategy is approximately Rs91,000. Note: The maximum loss would be incurred above Rs2,150.4 levels, which is 12% higher from the current levels. If SBIN overcomes the Rs2,150 level, then it would be advisable to close the strategy. (*) For any further clarification you can mail to nandish@sharekhan.com

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Payoff chart

PAYOFF DIAGRAM

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