The Nifty continues range-trading but it has a pattern of lower lows and lower highs over the last three weeks. On the downside, it has tested support at 5,435 and on the upside, it has failed to break resistance at 5,600. Given bearish long-term and intermediate trends, the likelihood is of a downside breakout.
Supports and resistance clustered at roughly 50-point intervals. A drop below 5,400 would set up a minimum target of at least 5,300.
However, there is also some chance of an upside breakout. The key levels to watch are 5,320 (low of May 25) and 5,175 (low of February 25). A break below 5,320 would confirm a sharp intermediate downtrend and a breach of 5,175 would create a new 52-week low. On the upside, a key level to watch is 5,670 (high of May 9).
Immediate target on breakouts could be till 5,300 or till 5,700. The institutional attitude remains lacklustre and volumes are average. The CNXIT is also range-trading, between 6,400 and 6,700, while the Bank Nifty is holding above support at 10,600. The Bank Nifty's direction is crucial since an RBI policy review is due. Another rate hike could push it below 10,500 and in that case, it would trigger a broader breakdown.
Three trading possibilities. A breakdown till minimum 5,300 is one. A recovery till 5,700 is another. The third is range-trading between 5,425 and 5,650.
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The Nifty put-call ratio (PCR) is normal with the June PCR and the overall PCR both at around 1.3. Daily volatility could expand to an average 125 points in the next five sessions if there's a breakout.
The June call chain has good open interest between 5,600c, 5,700c and 5,800c, with fair open interest (OI) at 5,500c. The June put chain has a big bulge in OI at 5,400p and another bulge at 5,000p with a fair amount of OI in the strikes between. The consensus expectation is moves between 5,300 and 5,800 with some traders hedging a bigger downside.
At one strike removed from money (Spot Nifty is 5,482) risk:reward ratios are excellent. A bullspread of long June 5,600c (38) and short 5,700c (15) costs 23 and pays a maximum of 77.
A bearspread of long June 5,400p (44) and short 5,300p (23) costs 21 and pays a maximum of 79. Those bullspread and bearspreads can be combined to create long-short strangle position. This has a positive risk:reward ratio with a net cost of 44 and a maximum return of 56 each-way. Breakevens are at 5,356, 5,644. It's quite attractive since it could provide some profits on both the legs.
Another possibility is the near-zero-delta long straddle of long 5,500c (79) and long 5,500p (80). This can be laid off with a short 5,300p and a short 5,700c to reduce net cost to 121. The theoretical maximum return is 79 with an adverse risk:reward ratio.; Breakevens at 5,379, 5,621.
But since the long position is on the money, any swing will lead to a spike in the value of one of the long options and thus, create fast trading gains.
A trader could cash the short put and the long call on an upswing. Vice-versa, cash the long put and short call on a downswing. This picks up profits if the market continues to range trade around a mid-point of 5,500.