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The market has corrected through four of the past five sessions and the global cues are looking a little weak. However, option premiums are still running very high and there is an undercurrent of optimism. The market is still close to its all-time high of Nifty 6,869 and there could be a big surge if the Bharatiya Janata Party (BJP) comes to power with a stable coalition. If the electoral results aren't so clear, there could equally well be a steep correction.
The last two weeks of the May settlement are very likely to see extreme volatility. Domestic institutions have been net sellers through April, while Foreign institutional investors (FIIs) have been net buyers and so has the retail segment. The dollar-rupee has been ranged between 60-61. Worries about quality of the fourth quarter earnings have surfaced on the fundamental side.
The Nifty is holding out above support at 6,700. The Bank Nifty is hovering around the 12,900-13,000 levels. Any major impetus to the bull market would have to include the Bank Nifty. The trader could hold a bullspread in the Bank Nifty with a long 13,500c (424) and a short 14,000c (263). The cost is 181 and the possible payoff is 319.
Conventional technical signals and fundamentals don't matter at the moment and even the fear of a poor monsoon is not a major short-term factor. Obviously, the long-term and medium-term trends are up, while a short-term correction seems to be in force.
The May Nifty option chain and the three month Nifty chains offer several signals worth noting. Premiums are massive on both the call and put side of the chains. The May Nifty call chain has large open interest (OI) at 7,000c, 7,500c and 8,000c. The put chain has high OI at 6,500p and also at 6,000p but not too much OI below 6,000. Trader expectations mostly range from about 6,000 to 8,000 - that is, about 12 per cent down and 18 per cent in the next three weeks.
The Nifty's put-call ratio (PCR) for May, June, July combined is at 1.12 and the May PCR is also at 1.1 This is a mildly bullish value and an improvement on earlier highly over-bought signals.
If the DIIs turn net buyers while FIIs maintain their current bullish stance, the market will be forced up sharply. The opposite scenario, FIIs turning sellers while DIIs remain sellers, could lead to a devastating correction. Either an only-buyers or only-sellers situation may result post-election. Until May 16, the market is not likely to gain or lose major amounts unless there are unexpected news developments.
There has been some decay in option premiums since the new settlement started. Option selling may still be possible but it no longer looks an entirely safe strategy. If you sell, set strict stop losses and be prepared to book profits quickly.
Given volatility expectations, deep bullspreads and bearspreads on the Nifty are possible. A long May 6,900c (175) and short 7,000c (139) costs 36 and pays a maximum 64 with the spot Nifty traded at 6,720. A long May 6,600p (189) and a short 6,500p (151) costs 38 and pays a maximum 61. Neither ratio is very attractive and strangles offer negative risk:return ratios anywhere within 300 points of the money.
