Nifty to trade in the 4,900-5,200 range

Last Updated: Mon, Jan 30, 2012 18:40 hrs

The Nifty saw a correction yesterday after it hit resistance near the level of the 200 Day Moving Average (DMA), above 5,200. If this downtrend continues, it could mean a reversal in the intermediate term. However, we have to wait and see if a phase of progressively lower tops and bottoms develops.

The Reserve Bank of India credit policy was disappointing, though not unexpected. Institutional support has been good through the past weeks. But Monday marked quite a bit of FII selling. The dollar-rupee rate strengthened to below 50 before it weakened again. Further trouble in Europe is spooking traders and investors.

The short-term trend seems negative. Breadth indicators are negative. Volumes are average, overall advance-decline ratios are negative. Intra-day volatility rose on Monday. The long-term trend continues to look bearish. A breakout above 5,225 could lead to a rally till 5,600, with the 200 DMA being pierced. But a drop below 4,900 would also lead to support at 4,600 being tested. Opening gaps of 25-50 Nifty points will continue to be normal. There is a fair chance the index will range-trade between 4,900 and 5,200 for the rest of this week, without a clear directional pattern.

Among subsidiary sectors, the CNXIT could fall till 5,700, if support above 6,000 breaks. The Bank Nifty is starting to look weak. If the Q3 results of key banks are not well-received, a drop till 8,700 is possible. As of now, support at 9,500 holds.

The Nifty put-call ratio is in a healthy zone of 1.3. Premiums have risen post-settlement, with the added spur of a big swing on Monday. Option chain examination shows that the February call open interest (OI) is concentrated between 5,100c(116), 5,200c (71), 5,300c (40) and 5,400c (19). The February put OI is focused between 4,700p (15), 4,800p (25), 4,900p (42), 5,000p (68) and 5,100p (109). One would guess that consensus expectations have widened, as is normal in the early stages of a settlement. Traders with a timeframe of five sessions could focus on the range between 48,00p and 5,300c.

An on-the-money bullspread of long February 5,100c (116) and short 5,200c (71) that costs 45 and pays a maximum 55. The risk-return ratio is quite tempting since this is very close to being hit. One step further away, a long 5,200c and short 5,300c costs 31 and pays a maximum of 69.

The close-to-money bearspread of long 5,100p (109) and short 5,000p (68) costs 41 and pays a maximum 59. This is not so attractive with the Nifty at 5,087. We can try a further-from-money position of long 5,000p and short 4,900p (42), which has a better ratio of a potential return of 74 versus a maximum loss of 26.

Looking at strangles, we can focus on the range between 4,800 and 5,300 given the high probability of range trading inside this zone. A long 4,900p (42) and long 5,200c (71) can be laid off with a short 4,800p (25) and a short 5,300c (40). This costs a maximum 48 and pays a maximum 52. There is a good chance both sides of the strangle combination will yield profits if you time entry and exit well. However, the risks and returns won't be symmetric, since the spot is much closer to the long call.

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