The Nifty has finally made a downside breakout after weeks of range-trading. It tested 5,197 before pulling back to a close of 5,258. As expected, volumes climbed and so did volatility. This looks like a decisive breakout with the previous (May 25) low at 5,320 smashed. The 5,175 level will be crucial since that is the annual low (5,177 on February 25). Given that the short-term trend is now in phase with the bearish long-term and intermediate trends, the likelihood is that 5,175 will be broken.
By definition, there’s not been much recent trading in this region so projections have higher error values. If there’s a pullback, it’s likely to hit clusters of resistance between 5,320 and 5,450. The institutional attitude remains lacklustre and the rupee is coming under pressure.
The CNXIT is down sharply and it could test the 6,000 level inside the settlement. The Bank Nifty broke below key support at 10,500 and it’s likely to fall further, maybe below 10,000 since there is selling pressure across financials. The action in the rupee and in the bond market, where yields are inverting, suggests specific weakness in the sector. The odds are heavily in favour of further losses but there are three trading possibilities. A breakdown below 5,200 is one – the target could be 5,000. A recovery till 5,500 is another. The third is range-trading between 5,200-5,400. The Nifty put call ratio is quite bearish in the June settlement at 0.9 and the overall PCR is hovering at around 1. About 75 per cent of option open interest (OI) is still in the June settlement, so that signal is clear. Daily volatility is likely to stay up. We may see several 150-200 point high-low ranges until settlement (June 30).
The June call chain still has a lot of OI at 5,500c (9) and 5,600c (5) and there is OI building up at 5,300c (54) and 5,400c (22). The June put chain has a lot of OI starting from 5,000p (16) and at 5,100p (28) and 5200p (53). Settlement and expiry consideration has led to a narrowing of OI in both chains and consensus trader expectations are now between 5,000-5,600.
The expiry effect means close-to-money (CTM) spreads offered excellent risk:reward ratios. A bullspread of long June 5,300c (54) and short 5,400c (22) costs 32 and pays a maximum of 68. A bearspread of long June 5,200p (53) and short 5,100p (28) costs 25 and pays a maximum of 75. Effectively, these spreads are zero-delta with respect to each other with the spot (5,258) more or less sandwiched midway. So, the bearspread looks better. The CTM bullspread and CTM bearspread can be combined to create a long-short strangle position. This has a negative risk:reward ratio with a net cost of 57 and a maximum return of 43 each-way. Breakevens are at 5,143, 5,357. It’s quite attractive despite the negative risk:reward, since it could provide some profits on both legs, if there’s a bounce.
It also looks like a fair gamble to take a wider zero-delta long strangle of long 5,100p and long 5,400c. The net cost can be reduced to 25 since there’s liquidity enough for a short 5,000p and a short 5,500c. The breakevens are 5,075, 5,425. This would work well if the market swings really sharply.