Dead cat bounce and my dream company: Reliance Communications

Dead cat bounce is an Investor slang, which talks about brief recovery in the price of a falling stock. Small amount of good news might lead to such bounce-back in dead stocks.

MTNL, Punj Lloyd, ADAG stocks are some examples of dead cat stocks in the Indian market. RCom is one among them and my dream company to trade as option writer. Implied Volatility’s (IV’s) always remain high in the range of 70-75% and spike up substantially in case of any adverse news-flow. Option premium always remain high due to high IV’s. Last week, a day before court rejected petition to include Mr. Anil Ambani in the charge sheet filed by CBI, IV’s in RCom puts spiked up sharply. Spot price was 90 and puts  as low as 50 level were open for trading. I looked at 90 call and 90 put, both were trading at Rs.6 odd. It was quite clear to me that the market did not have  any indication what so ever on the verdict. I went ahead and sold 60, 65 and 70 puts. Even if  the verdict was against him, stock tanked 10-15% next day, I doubt if it would have closed June series at those levels. Puts which I wrote were 30-40% away from spot level. Since the verdict went in favor of  Mr. Ambani, puts premium tanked 70-80% next day. My returns from 70 puts were 13.43% in 29 days. There is news about RCom selling its stake in tower company, in case it happens RCom is due for dead cat bounce. Given the levels of debt RCom has on its books, tower sale is extremely crucial for them.

Slowing China – Biggest Risk in writing Calls in Indian market

India is an evolving market and will continue to do so over the next 20 years. Foreign Institutional Investors (FII‘s) continue to dominate Indian market and their inflow continues to decide its direction. Last year, when FII’s pumped billions of dollars, market went up but this year when inflows are not so strong market is struggling to go up. Not many people invest in Equity markets and Mutual fund. The biggest problem I think, is the lack of stable long-term pension money. But over long-term with or without FII money Indian market will continue to go up and you don’t need any kind of BRICS marketing gimmick to confirm that. Structurally, we are in a bull market for next several years, but within that we will continue to overshoot and undershoot our long-term mean valuation of 15 PE. As option writer, I keep waiting for these overshoot and undershoot opportunities.

Last sunday there was an article in Business standard on slowing Chinese economy which might lead to sharp correction in commodities. http://www.business-standard.com/india/news/china-slowdown-may-lead-to-75-dip-in-commodities/437850/. As OTM Call writer, I would watch the situation in China very carefully since, rising commodity prices especially crude oil prices has been a major overhang on Indian markets this year. This quarter results confirm pressure on operating margins, rising input costs, rising interest rates and with slowing Indian economy, situation doesn’t look very good. But lot of this could change if there is some kind of slowdown in world’s biggest consumer of commodities leading to sharp pullback in commodities.

For June series I sold M&M 740 call, Tata Motors 1200, 1250 & 1300 Call. M&M quarter result clearly reflect pressure on margins, which were lowest in last eight quarters and might fall further. M&M Stock saw sharp reaction on result day. Tata Motors is struggling in domestic Commercial Vehicles (CV) segment, although Jaguar Land Rover (JLR) contributes close to 50% of overall sales. Given poor economic data coming from US and Euro zone,  if there is slight slowdown in JLR sales coupled with slowing growth of Indian CV market then Tata motors is struggling big time. But lot of things might change for companies like M&M which have strong domestic business (tractor segment), if there is sharp pullback in commodities. Inflation may also come down quite sharply and ease pressure on RBI to raise interest rates, hence need to be careful while writing calls of companies like M&M.

Benefit from Sun TV drastic fall

As option writer, I love the kind of events that happened in Sun TV last week. As the news broke out, Mr. Maran might have misused his power to benefit the family business, Sun TV saw drastic fall – closer to 30 percentage. Due to this drastic fall in Sun TV, Implied Volatility in its options increased substantially to 150%. Are these IV’s sustainable ? Answer is no in short term since  stock will remain volatile over next few days and will take time to stabilize. But after next few days IV’s will surely come down from unrealistic 150 odd level.

Options in Sun TV were quite illiquid(low or no trading volume) before this fall. But now situation is just opposite and options from 180 put to 400 call are quite liquid. Given the negative news flow emanating not just related to 2G scam but also on business front from Chennai, it looks extremely difficult for Sun TV to go back and test 380-400 levels. One can write OTM 380 or 400 calls for June series resulting in 6.8% and 3.5% returns respectively in 27 days (assuming 10% margin requirement of contract value).   Writing puts in this case can be quite risky since no one knows the extent of damage which can occur in the stock. As of now, I have written one OTM 400 call and looking to write some more 380 calls in case stock rebounds.

First post

I have been writing options for quite some time. Writing or selling options is quite risky since your gains are limited to premium collected while your loss is unlimited, as shown by the black swan event like 2008 market crash across the world. As option writer, one stands to benefit from Implied Volatility(IV) and Time decay. IV as implied by the option premium, is the rate and magnitude of change in underlying prices. Time decay says that if underlying does not move much then, option will expire worthless (represented by greek theta). Anyways, options are wasting assets and their value declines over time.

Trading in options has increased significantly in Indian markets over last year and this is reflected in falling margins of major brokerage houses. Within option segment, Index options attract majority of volumes.

If you think market or stocks will remain range bound over extended period of time then, option writing is the way to go. Normally, I write Out of Money(OTM) Calls on individual stocks and rarely OTM Puts. First of all, I identify stocks which have announced either poor results or affected by any new development or major event which will impact their business significantly. Usually, these stocks take some time to recover and you stand to benefit from time decay. For e.g. – Infosys announced its Q4, 2011 results in April this year and market didn’t like its performance which was evident in stock reaction that fell 7 odd percentage. One could have easily sold its OTM Calls at 3300 or 3200 strike price and made quite a bit of money. Given the kind of selling which Infosys witnessed on huge volumes, it was extremely difficult for Infosys to go back and test 3200-3300 levels. I sold one 3300 Call for May series which was trading at Rs 19 that time. Writing options usually involve some kind of margin commitment and hence you calculate returns on margin provided. My returns on writing Infosys call were 4.59% in 18 days, which is quite decent by any standard.

Over next several posts, I will keep giving examples of trades which I have executed or about to execute. I believe, writing options if done sensibly can yield 25% annualized returns.