How to play Infosys in F&O ahead of its Q2 results

Earnings season kick starts this Friday and as usual Infosys will be the first off the block among the heavyweights. It's a stock which is notorious for big moves on results day and option traders are hugely active sometime around now to play for the result day move. Let’s just see what is being priced in.

First of all, I just looked at the charts of last 2 months and one thing that stands out is that Infosys has been stagnant around Rs 3,000 mark. During this period, TCS has moved up 9 percent, while HCL Tech has moved up a whopping 22 percent. Even year to date, HCL Tech leads with 77 percent gains, TCS is second with 62 percent and Infosys lags with 30 percent gains. Of course, it is still among the best performing Nifty stocks.

Now, look at the valuations for FY14-end. TCS trades at 22x, HCL Tech is at 14x, and Infosys is in between at 16x. Of course, TCS deserves its premium for its consistency and HCL Tech still needs to do more work to bridge the gap.

But what we are focusing on here is the pricing of Infosys options. Over the last three quarters, Infosys stock has moved by an average of 15 percent on results day. On result days, this was the trend: In January 2013, it rallied 17 percent, while in April 2013, it fell 18 percent and in July it rallied 11 percent.

Anecdotally, it would have been a good strategy if you had bought Infosys at the money straddle – or in simple terms both call and put of same strike closer to the market price. But this strategy worked only in January and April because the moves were so sharp. In July, even after 11 percent move, the straddle buyer would have actually lost money and the reason is the spike in implied volatility. Look at the data for this month for example.

The combined premium of Infosys 3000 Call and Put is Rs 400. Simply put, you need a move of over 13 percent on either direction to make money if you have bought this straddle. And what’s intriguing is that we are still 5 days from the results and in all likelihood, this premium may actually rise. The reason is the incredibly high implied volatility of 60 percent. So what should a trader do?

Well, wait for this implied volatility to rise more and if it approaches 80 percent-90 percent which is not impossible, it just might make sense to actually sell this straddle on Thursday and you will still make money if the Infosys stock moves even 10-12 percent. Of course keep in mind, this strategy has a risk just in case the stock moves 20 percent or beyond.