Who wrote this article?

Deepak Shenoy, Capitalmind's research team.

Optionalysis: How STT Affects Option Prices (Plus, Portfolio Changes)

Q: What does the "And now, the portfolio update." section say?

DLF saw a huge risk, with their announcement that they sold Aman Resorts for $358 million on Sunday. The stock opened at Rs. 145, the stop loss on the trade, but we held on primarily to let a bar close above 145, which didn’t happen. The stock closed at 142, and the 145 call option fell from a day’s high above Rs. 6 to Rs. 4.70.

Q: What does the "IDFC, a Long Setup" section say?

We’re seeing a potential long play in IDFC, which has multiple entry signals:

This is an archive for Capital Mind Premium subscribers, sent on Feb 8, 2014.

A number of options traders start taking positions and hold them too long, and then we have the uniquely Indian situation where options on expiry day could trade below even their intrinsic value! A holder of a Nifty 5,500 call might be surprised to find the option trading at Rs. 495 when the Nifty is at 6,000. This goes against all logic, because the option is supposed to at least have as much value as will be paid out if the option expired right now.

The reason it trades lower than intrinsic is due to India’s taxes - the Security Transaction Tax. We made a video - as part of our sister company, Market Vision - on how STT impacts option prices closer to expiry and would encourage you to click and see it:

The Low-Down:

STT is much higher for options in the money at expiry
The difference causes options to trade lower than expected, even lower than intrinsic value
If you own options that are in the money, sell them before expiry to not lose this value
Typically options trade at the “STT Discount” around one or two days before the expiry date.

And now, the portfolio update.

DLF saw a huge risk, with their announcement that they sold Aman Resorts for $358 million on Sunday. The stock opened at Rs. 145, the stop loss on the trade, but we held on primarily to let a bar close above 145, which didn’t happen. The stock closed at 142, and the 145 call option fell from a day’s high above Rs. 6 to Rs. 4.70.

However, the stock is in danger and we would exit the option completely. (Loss: Rs. 3,200 on one contract of 2000 shares)

Luckily this was made up by the PETRONET trade. We had earlier exited one option at Rs. 2.35 after having bought at Rs. 1.75. The second contract found a buyer at Rs. 3 today, which is what the option went to when the price crossed Rs. 119. (Profit: Rs. 3700 on 4000 shares)

ICICI Bank saw a marginal dip but the time value worked for us as the options that were sold at Rs. 9.6 are now avaiable for Rs. 6.6. No further action until Rs. 1,000 is breached. Would be prudent to book profits if the option falls below Rs. 3. (Current Profit: Rs. 1,500 on 500 shares).

IDFC, a Long Setup

We’re seeing a potential long play in IDFC, which has multiple entry signals:

MACD Cross
Covers a Gap and could potentially break out tomorrow
Closes above 20 DMA
RSI crosses above 50

There is momentum, and there’s a sort of trend. The target is 103, which is a 50% retracement of the current downmove. This coincides with the last intermediate high, and could be a strong resistance.

At this point a high risk trade would be to wait for the gap cross above 98, and target 103. We would trade this through a **debit call option spread **- buy the 100 call (Rs. 2.4), sell the 105 call (Rs. 1.1).

Why? The analysis shows that the stock will falter around 103. Falter, in long options, is expensive in terms of time decay, so we short an option above it to cut the cost of the long option we own. We might have to do 4,000 shares (1 contracts) and keep a stop at the last low (Rs. 90). The risk is contained; The maximum we’ll lose is Rs. 1.3 per share.

An alternate mechanism is to do a weighted spread, where we would write two of the 105 call options, and go long one 100 call. This reduces the cost of the spread to Rs. 0.2 per share, but increases the risk (you start losing money if the share crosses 107.5).

The Nifty Confuses Us

The Capital Mind MA20 indicator tells us the Nifty might be starting on a new uptrend:

The Capital Mind MA20 is Capital Mind’s proprietary indicator built by taking the number of stocks above their 20DMAs, and subtracting the number below, and then smoothening out the resulting series. As you can see, this oscillates between +50 and -50 and when it reverses from the 30 levels in either direction, it indicates a change in trend.

Right now the MA20 has just gone up from the -30 level. The Nifty, through, shows a short term reversal in the hourlies, potentially triggering tomorrow.

We would want to buy put options for a fast move down if the Nifty opens low tomorrow. I would not write further call options at this point because there is event risk in all directions - news flow from the trade deficit, IIP, Inflation (WPI and CPI) and a mini-budget this month makes a little difficult to write on the Nifty. And there is no real trend to trust here.

A longer term trend might be visible if the MA20 indicator rolls up above -10, and we would consider **buying calls **then, at the 6200 level, for a March expiry. (To give it enough time to work)

It’s a little confusing but a trading plan is exactly this:

if X happens, this is what I will do
If X doesn’t happen, then I won’t do anything.

(Repeat for every point X that is adverse and for every X that is favourable to your positions)

Of course, don’t follow this blindly, this is not a tip or portfolio advisory service. We only aim to educate.