Breakout could mean 8,200-plus levels on the Nifty

Last Updated: Tue, Sep 02, 2014 09:30 hrs

The market indices burst through to new highs, on the basis of strong first quarter (Q1), 2014-15, gross domestic product (GDP) performance and successful visit to Japan by the PM. The Nifty crossed the 8,000 barrier on Monday and the Sensex also moved closer to 27,000. There was heavy retail buying and that filtered through to smaller stocks.

The Nifty, Sensex, Bank Nifty, etc, have all hit new highs. Volumes are reasonable and breadth is good with advances outnumbering declines. The market continues to have bullish trends across all time-phases, by definition, since it is logging higher highs.

The breakout could mean targets of 8,200-plus or maybe 8,500. It is impossible to set targets with any confidence, given that all indices are in new zones. It's also true that even a two to three session correction, could mean a fall till 7,800 or lower. As a rule of thumb, day-traders should assume congestion will be visible at 50-point Nifty intervals.

Given that the market could move by a significant amount, the VIX is very low in the early teens, although it is rising now. This implies that the market is seriously under-pricing premiums on close to money Nifty options. This is classic behaviour close to market tops.

The Bank Nifty remains a key driver for any sustained trend. The financial index has broken through the 16,000 level. The futures are trading at premiums of close to 150 points above the spot index, which is high, and could indicate an overbought uptrend. The nearest support on a correction could be 15,975-16,000. Upside targets are difficult to call but 16,750 may be a possible target. The Nifty futures are also at substantial premium over spot.

The market is also waiting for signs of a possible Eurozone stimulus from the European Central Bank. If this occurs, the dollar could harden and the Euro could soften versus the rupee. Under other circumstances, large foreign institutional investor (FII) inflows could mean the rupee rising sharply, or the Reserve Bank of India (RBI) being forced into action to keep the rupee inside an acceptable band.

As mentioned above, September Nifty options premiums are low. The put-call ratios (PCRs) have reverted to over-bought levels and this could mean some sort of short-term correction. The three-month PCR is at 0.98 while the September PCR is just above one. However just two sessions into settlement, these ratios are not reliable indicators of sentiment.

A look at the option chains does indicate where traders think short-term moves could go. The Nifty Call chain has massive open interest (OI) at September 8,200c but there's high OI through till 8,400c and acceptable OI at 8500c. The Put chain has a lot of OI down till 7,500 with peak OI at 7,900p. Based on this, a short-term (say, three-session perspective) view implies the expectations are that the Nifty will not move outside fo 7,900-8,200.

The spot Nifty index closed at 8,029 with the futures at 8,072. An close-to-money bullspread of long Sep 8,100c (88) and short 8,200c (48) costs 40 and pays a maximum of 60. A close-to-money bearspread of long Sep 8,000p (78) and short 7,900p (49) costs 29 and has a maximum payoff of 71.

These two are close to money. The bearspread is quite tempting with a good risk:reward ratio. However, it's early in the settlement and wider spreads are possible. A long 8,200c (48) and short 8,300c (23) costs 25 and pays a maximum 75. It is possible to combine a long 7,900p(49), long 8,200c (48), short 7,800p (30) and short 8,300c (23). This set of long-short strangles costs 44 and pays a maximum of 56. Breakevens are at 8,244, 7,856.

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