The market seems to be in the early stages of a breakdown. The Nifty has set up a pattern of successively lower tops and bottoms and dropped below support at the 5,600-5,625 level. As of now, the expectation would be a further fall till somewhere between 5,400-5,450 within the November settlement (November 29).
The short-term support for the Nifty is between 5,525-5,550, with short-term resistance at 5,625-5,650. A bounce till 5650 would suggest that the breakdown was a false signal. The drop out of the trading range of 5,600-5,800, which the index had maintained for the past several weeks, suggests that it could fall till around 5,400 level or lower. There is plenty of congestion in this 5,400-5,600 zone so, it's very unlikely to come with an unbroken trend. If there is a bounce back till above 5,650, the previous pattern of range-trading 5,600-5,800 would resume.
The Nifty is far above its own 200-Day Moving Average so one would have to assume the long-term trend is still bullish. The considerable length of the previous intermediate range-trading period could be mirrored by a net fall through the next six-eight weeks however. So we may see the market lose ground till early 2013.
Volumes remain reasonable but on the lower side. The FII attitude continues to be net positive and DIIs remain net sellers. The USD has moved above 55. The USD is set for some volatility, given the US fiscal cliff and also continued trouble in the Eurozone. The USDINR could swing anywhere between 53.5 to 56.50. If FII buying support eases off, the USD could appreciate even more.
The Bank Nifty is looking weaker with marked pressure on PSU banks. The key support is between 11,125-11,175. On the upside, there's resistance above 11,500. If the overall market does break, the high-beta BankNifty is likely to lead the way and it could fall till 10,900 if support at 11,125 is broken.
Traders remain braced for a big move in November but expiry effects are visible in far-from money options. The Nifty Put-Call Ratios are bearish. The November PCR is around 0.97 while the three-month PCR is 1.03.
Option chain analysis suggests quite a few traders are still optimistic about a bounce. But a lot of downside hedging is also evident. The November call chain has very high open interest (OI) between 5600c (45), 5700c (14) and 5800c (4) with the OI peak at 5800c. The put chain has high OI from 5200p (2), 5300p (3), 5400p (6) , 5500p (20), and 5600p (55).
Since the underlying index is at 5,570, with the futures at 5595, positions aren't zero-delta. The premiums are skewed in favour of calls. The very short-term expectations of the next three sessions would be between 5,475-5,650. By end-settlement, prices could have moved anywhere between 5,400 and 5,725.
Near-the-money return to risk ratios are better for bearspreads but also okay for bullspreads. The bullspread of long November 5600c (45) and short 5700c (14) costs 31 and pays a maximum 69. The bearspread of long November 5500p (20) and short 5400p (6) costs 14 and pays a maximum 86.
Combining the above yields a long strangle of long 5600c, long 5500p, combined to a short strangle of short 5400p, short 5700c. This costs 44 and pays 56 with breakevens at 5456, 5644.