The market has seen an amazing bounce. The Nifty tested support at 5,118 on August 28, before it hit 5,900-levels on Tuesday. The move has been led by financials. The bank Nifty has moved from a 52-week low of 8,366 to hit resistance above 10,300.
The rally has been strong enough to suggest the long-term trend may be reversing. The Nifty has broken out above its own 200-Day Moving Average (DMA). Volumes have been good and the advances-declines ratio very positive.
This breaks the pattern of lower lows and lower highs, confirming an intermediate uptrend since August 28. The next key mark on the upside would be 6,093 to maintain the pattern of higher tops. The next target would be 6,230 to confirm this is a new bull-market. On the downside, the first support is at the 200 DMA levels of 5,825-5,850.
A characteristic of bear market rallies is those tend to be very sharp and fizzle suddenly. We'll have to see where the market runs out of steam. The Nifty faces continuous resistance at every 50-point interval. If it breaks down, it could drop equally sharply back till 5,300 or lower.
The US Federal Reserve will decide on tapering on September 17-18. The new Reserve Bank of India (RBI) governor will announce monetary policy on September 20. If the Fed does nothing, the RBI gets some leeway. If the US tapers, the RBI will have to raise rates to maintain yield differentials between dollar and rupee. Bond yields have risen in both markets; tapering would push dollar yields up again. Meanwhile, the Syria flashpoint may be defused, at least temporarily.
The rupee has stabilised to some extent. This could mean outflows from information technology and pharmaceuticals into more speculative sectors. There have been speculative investments in automobiles and telecom. Other rate-sensitives like non-banking financial companies and capital goods have followed the lead from banking.
There are too many potential negatives to be very comfortable with going long. This could easily be a bull trap. Apart from the interest rate perspective, one would like to see the Nifty consolidate above 5,825-5,850.
Nifty put-call ratios are looking okay. The September PCR and the three-month PCR are both near 1.6. Options close to money are high-priced. But puts are markedly higher-priced than calls. Expectations in four-five sessions range 5,600-6,200, given the strangle of long 5,900p (137) and long 5,900c (140).
A problem is all premiums appear geared to high-volatility expectations. There could be a rapid decay in premiums just before the volatility actually hits in settlement week. A bullspread of long 6,000c (91) and short 6,100c (53) costs 38 and pays 62. A bearspread of long Sep 5,800p (100) and short 5,700c (73) costs 27 and pays a maximum 73. A strangle of long 5,700p, long 6,100c, short 5,600p (52) and short 6,200c (29) costs 45 and breaks even at 5,655, 6,145.