The bearish bias was confirmed, with a new Nifty 52-week low of 4,531. The breadth indicators are negative. Volumes have fallen, the advance-decline ratios are negative and domestic traders are waiting for the foreign institutional investors (FIIs) to give an inkling about their intentions in 2012.
Intra-day volatility dropped in the last week of 2011, and so has implied volatility. Successive 52-week Nifty lows of 4,560 and 4,531 have been backed by resistance in the 4,800-4,900 zone. That has led to a pattern of lower peaks as well. We could classify the long-term and intermediate trends as bearish, while the short-term trend is indeterminate.
The rupee remains weak. Now that the market has busted support at 4,600, the next big breakout is more likely to be a slide to the 4300-level than a positive move. As volumes pick up, the daily high-low swings will widen. Opening gaps of 25-50 Nifty points will continue to be normal.
In the broader market, smaller stocks are suffering from lack of liquidity and this is a problem even for some mid-caps in the derivatives segments. Among important subsidiary sectors, the CNXIT may continue to outperform, given a weak rupee. The CNXIT has managed to climb back over 6,200 but it faces major resistance above 6,350.
The Bank Nifty has hit new 52-week lows and all indications are that it will slide more than the Nifty. The pattern of new 52-week lows across the financial sector has been quite depressing. However, the Bank Nifty is also likely to lead recoveries.
The Nifty put call ratio is hovering just above the danger mark at around 1.1. In the January call series, open interest peaks at 5,000c (16) with ample OI at 4,700c (93), 4,800c (56) and 4,900c (31). In the January put series, OI peaks at 4,500p (70) but there’s ample OI both above, at 4600p (103), and below, at 4,400p (45) and 4,300p (28).
Consensus expectations are spread across the wide range of 4,300 and 5,000. This reflects an extremely nervous, thin market, where the implied volatility of the current premiums is understated. Given that it’s early into settlement, we can focus on a wide range, hoping for breakouts.
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A close to money bullspread of long December 4,700c (95) and short 4,800c (56) costs 39 and pays a maximum 61. The close-to-money bearspread of long 4,600p (103) and short 4,500p (70) costs 33 and pays a maximum 67. With the index at 4,640, these spreads are practically equidistant and the risk-return ratios are decent.
A wider bearspread of long 4,500p (70) and short 4,400p (45) costs 25 and pays 75. The wider bullspread of long 4,800c (56) and short 4,900c (31) also offer a maximum cost of 25 and a maximum gain of 75. If we combined long 4,600p, long 4,700c, short 4,500p and short 4,800c, we get an adverse ratio of maximum loss 72 and maximum one-way gain of 28. However, this close-to-money long-short strangle is guaranteed to be struck and it may be struck both ways.
If we combine a long 4,500p, long 4,800c, short 4,400p, short 4,900c, we create a long-short strangle with an even risk-return ratio. The maximum one-way payoffs are 50 each and the maximum loss is 50. This looks tempting.