Category: Investing Insight

Investing insight to make you a better investor.

Analysis: Bhavin Desai’s Bull Spread on ITC

Bhavin Desai of Motilal Oswal Securities was on CNBC saying that one may buy ITC 350 Call and advises shorting 360 Call. This is a 350/360 long call spread on ITC. Let’s see how the trade works.

The greeks

ITC Bull Spread Greeks

The 360 call has a θ of -145.36 and it the model premium is 3.04. This means that the time decay will make the option worthless in a couple of days. Not bad since you are an option seller.

The 350 call is already ITM (the stock closed at 352.70) and the last traded price, Rs. 6.3 is less than the model price of Rs. 7.49. Not a bad deal.

Payoff diagram at expiry

ITC Bull Spread P&L

ITC Bull Spread Breakevens

ITC needs to be above Rs. 354.35 at expiry for this trade to break-even. Max loss is the premium paid upfront (Rs. 4350)

The right trade for the wrong reasons?

The transcript on moneycontrol says:

ITC has had some amount of shorts right from the beginning of this expiry and since then it has not done anything and once again since yesterday’s trade we have been seeing some amount of long additions. So, a call spread or rather a bull call spread is something that can be advised.

We are not really sure what that means. The reason why you would put a bull spread on is if you are moderately bullish about the stock and want to mitigate the cost of buying the lower strike by selling a higher strike.


Buy ITC 350 Call, short 360 Call: Bhavin Desai

Options Liquidity

Liquidity (or the lack thereof)

Open interest is a measure of liquidity of a particular market. For each buyer of a contract there must be a seller. From the time the buyer or seller opens the contract until the counter-party closes it, that contract is considered ‘open’. OI refers to the total number of derivative contracts that have not been settled.

Other than a few select indices and stocks, there is absolutely no liquidity in the option market. Here’s a chart of the latest total OI for the nearest (April) expiry:

OI April

And its worse for the next series:

OI May

Bid-offer spread

The problem with trading illiquid options is that the bid-offer spread ends up killing your trade. Compare and contrast the spreads for UNITECH and DABUR:





Don’t stop at trade setups

When you conceive option trades, make sure you consider liquidity constraints. Otherwise, your trade is likely to remain on paper.

The liquidity footprint is not static. For example, RCOM, which was #8 in Jan is nowhere to be found in the liquid dozen in April:

OI Jan

Monitoring liquidity risk is as important as checking your deltas and P&L and can often make or break a trade.

Introducing The Facebook National Bank

We had pointed out back in February as to how startups are disintermediating banking and that given the amount of data that both banks and Facebook have on us, it is only a matter of time that we saw a “Facebook National Bank.” Turns out that it is now a reality:

Facebook is readying itself to provide financial services in the form of remittances and electronic money. The social network is only weeks away from obtaining regulatory approval in Ireland for a service that would allow its users to store money on Facebook and use it to pay and exchange money with others. “Facebook wants to become a utility in the developing world, and remittances are a gateway drug to financial inclusion.”

Source: Facebook targets financial services

Study reveals why economists suck at making predictions

The ability of forecasters to predict turning points is limited. Forecasts from the official sector, either from national sources or international agencies, are no better at predicting turning points.

So the explanation for why recessions are not forecasted ahead of time lies in three other classes of theories, which are not mutually exclusive.

  • One class says that forecasters do not have enough information to reliably call a recession. Economic models are not reliable enough to predict recessions, or recessions occur because of shocks (e.g. political crises) that are difficult to anticipate.
  • A second class of theories says that forecasters do not have the incentive to predict a recession, which – though not a tail – event are still relatively rare. Included in this class are explanations that rely on asymmetric loss functions: there may be greater loss – reputational and other kinds – for incorrectly calling a recession than benefits from correctly calling one.
  • The third class stresses behavioural reasons for why forecasters hold on to their priors and only revise them slowly and insufficiently in response to incoming information.

A more than a healthy dose of skepticism is always warranted when dealing with these so called “expert forecasts.”

Source: “There will be growth in the spring”: How well do economists predict turning points?

What can Modi do?

The following are excerpts from a recent JP Morgan special report titled “India: elections, markets & the tyranny of economic reality.”

The equity market exuberance, however, appears based on opinion polls increasingly pointing to a stable government post election, and the presumption of a dramatic economic pivot post election that jump starts a new capex cycle.

EM India Flow

The broad hope is that a positive cycle can be unleashed if projects get unclogged, increasing cash flow for infra companies (which account for 30% of stressed loans), enabling loan repayments, and healing bank balance sheets, which can allow a fresh lending cycle to start.

India stalled projects

But the problem is that the vast majority of projects are currently stuck because of issues that are under the purview of state governments, over which the central government has little jurisdiction.

India stalled projects reasons

And even if these problems were magically resolved, where is the money going to come from? Among the BSE-200 non-financials, 17% have operating incomes (before depreciation, interest and taxes) that are less than the perilous threshold of 1.5 times their debt service obligations. So a significant deleveraging would need to be undertaken before these infrastructure companies have the balance sheet strength to finance another investment cycle. This is a multi-quarter process.

India debt to equity

Banks are not in a position to lend. Public sector banks – which account for 70% of banking sector assets – are saddled with the overwhelming majority of impaired loans, and would need a significant quantum of capital injection by the government – far in excess of what has been budgeted – to finance any large pick-up in credit growth.

India bad loans

Given the economic reality on the ground, the translation from political stability to economic performance is likely to be far more lagged, incomplete and uncertain than the current market euphoria may be betraying.