The coming months may provide investors with an opportunity to make extra bucks through the arbitrage route as the government starts divesting its stake in major public sector companies through follow-on public offers (FPOs). An arbitrage opportunity arises when there is a good gap between floor price and the current stock price.

IN simple terms, if there is sufficient difference between the present market price of a stock and the FPO issue price, there can be good arbitrage opportunities.In such cases, investors can apply for the FPO at issue price and go short in futures and options (F&O) at market price, thereby freezing some profits.

However, one should be cautious as the arbitrage strategy involves substantial capital requirement and transaction costs. Also, additional capital infused may dilute the overall return on investments.

According to Ambareesh Baliga, head of research at Karvy Stock Broking, an arbitrage opportunity arose in the latest NTPC FPO, when the issue price was announced. “At that time, the February futures were quoting at Rs 212 and March futures were going at a discount to February price at Rs 210.

This allowed a straight arbitrage of 4 per cent to 5 per cent net of brokerage, as applicants to the FPO would get their allotments by the end of the month,” he said.

“This looked like a safe arbitrage opportunity as both HNI and retail portions of the FPO were under-subscribed and arbitrageurs will be able to get the quantity they had shorted without applying for additional quantity. Even the cost of capital is comparatively low if one were to use the Asba route,” Baliga pointed out.

Deven Choksey, managing director of KR Choksey agrees that the FPO created an opportunity for investors to earn more than 3 per cent return on investments within a short time.

“We created a strategy for all types of investors. We asked aggressive investors to sell February 205 PE at Rs 4.5, tgt-0, SL - 7.6, ROI - 10.3 per cent. (Selling a put option for Rs 4.5 and collecting the premium with a target, where the stop loss should be 7.60 and return on investment would be 10.3 per cent, assuming the investment in this case is the margin which one needs to pay to sell the put option.) Moderate investors were told to sell February 200 PE at Rs 2.65, tgt-0, SL - 4.65, ROI - 6.1 per cent. Conservative investors sold February 195 PE at Rs 1.75, tgt-0, SL - 2.75, ROI – 4 per cent. The investment required was Rs 71,000,” Choksey said.

However, Jagannadham Thunug-untla, head of research at SMC Capitals, says, “The spread between the current market price of Rs 205 on Friday and the issue price of Rs 201 is too thin to execute any meaningful arbitrage strategy. The insignificant return involved in the strategy may not justify the risk involved,” he said.

Experts say the arbitrage opportunity is generally availed by big FIIs and institutions —LIC and SBI as in the NTPC case — while retail investors are advised to stay away from taking such risks. Big institutions have sufficient funds to back themselves and can hope to get maximum allotments after shorting their derivative positions.

If an FPO is under-subscribed or not oversubscribed by large multiples, the chances of retail investors getting a decent allotment are very high. In the case of the NTPC issue, the retail subscription was low at 5.18 crore shares against a reserve of 14.28 crore shares. This means the chances of investors getting full allotment are very high.

However, experts say retail investors have become ‘very intelligent’ in putting their money in initial public offerings and follow-on public issues. “There was little arbitrage available for investors as far as the NTPC issue was concerned. With a volatile market, investors have become very cautious,” a Mumbai-based broker said.

Deven Choksey counters. “Sell-ing stocks in cash market and bidding for FPO will lead to less allotment of shares than one had applied. So, we feel the better way to earn returns on the NTPC FPO would be to use the strategy mentioned above,” he said.

Some experts say the poor investor response to the NTPC offer may jeopardise the chances of other FPOs lined up for February and March, like that of Rural Electrifi-cation Corporation (REC) on Feb-ruary 19 and NMDC on March 10.

Experts say unless the government does something to increase participation of retail investors in FPOs and IPOs, these issues should no be allowed to scrape through.

Choksey suggests that investment bankers and the government should spilt these issues into two parts. The first part should be open for QIBs and after it gets subscribed, they should open it for retail participants at a discounted price. He said the NTPC share had moved to Rs 250 before the issue price was announced in anticipation of higher FII participation. However, when they announced an issue price of Rs 201, it led to selling pressure on the counter.

The NTPC stock weakened in the secondary market over the past few sessions, it is likely to remain weak in the coming days. However, the stock is believed to be a good long-term bet with an upside of almost 25 per cent in 12 months. Several brokerages have pegged the 12-month target price for the stock between Rs 220 and Rs 255.