Sell Bullish Options on Indian State Banks on Rates, Morgan Stanley Says

Investors should sell bullish options on India’s state-owned banks because their values may fall as lower lending profits reverse the “strong” revenue growth of the past two years, Morgan Stanley derivatives strategists said.

Viktor Hjort and Gaurav Rastogi recommended selling six- month over-the-counter CNX Bank Index call options with a strike price 10 percent above the index level. The 12-member gauge has rebounded 12 percent from a six-month low on Feb. 10. State Bank of India (SBIN) Ltd. and the six other state-owned banks account for 34 percent of the index weight, the report said.

Net interest margins, a measure of lending profitability, are likely to fall “sharply,” the Hong-Kong based strategists wrote. Anil Agarwal, an analyst at Morgan Stanley (MS), expects the lenders to face “challenging” conditions over the next six to nine months as the higher cost of oil reduces asset prices, they said. That means there may be “little upside” for the index, which makes call selling attractive, they said.

“Our cautious view on Indian financials is based on a sharp slowdown in revenues,” the strategists wrote. “Oil prices will put pressure on asset quality.”

The index’s three-month implied volatility of 26 is a “high” premium relative to the one-month implied volatility of 16, the strategists wrote. That elevated cost for the longer- dated contracts favors selling the calls, they said.

Crude futures lost 53 cents, or 0.5 percent, to $112.99 in after-hours trading in New York after rising as high as $114.83 yesterday. Prices are up 31 percent the past year.

The CNX Bank Index gained 0.8 percent to 11,330.65 as of 10:49 a.m. in Mumbai, after falling 2 percent yesterday, ahead of the central bank’s policy announcement later today.

Inflation Risks

India’s inflation risks have “amplified” because of high commodity prices and “policy interventions” are needed, the central bank said yesterday after markets closed, signaling the possibility of raising borrowing costs today. It has increased rates eight times since March 2010.

Calls give the right to buy a security for a certain amount, the strike price, by a set date. Investors use options to guard against fluctuations in the price of securities they own, speculate on share-price moves or bet that volatility, or stock swings, will rise or fall. Over-the-counter options are traded privately with financial institutions, as opposed to listed options, which trade on exchanges.

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To contact the editor responsible for this story: Nick Baker at

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