Option analysis suggests market is in overbought territory

Last Updated: Tue, Jul 16, 2013 05:41 hrs

The market continued to gain, with the Nifty moving above the 6,000 mark, despite disappointing gross domestic product (GDP) data. Inflation is up on both the Consumer Price Index and the Wholesale Price Index. The Index of Industrial Production went negative. The rupee hovered around 60 against the dollar. First quarter (Q1) results kicked off with Infosys delivering the high end of consensus and the stock jumped 11 per cent.

The rupee could be stabilising at this new level. Foreign Institutional Investors (FIIs), which sold through early July, were net equity buyers in the past two sessions though they continued to sell rupee debt. Optimists hope the Reserve Bank of India (RBI) will cut policy rates at month-end but the falling rupee and rising inflation might mitigate against that.

The Nifty's momentum may be slowing. The current support is 5,975 and it should test resistance at above 6,050. This is an intermediate uptrend with rising tops registered when the index passed 5,905. Technically speaking, the market has been in an uptrend for three weeks. On the upside, there's heavy resistance until the 52-week top of 6,230, hit in late May. On the downside, key support exists at 5,850-5,875, where the 200-Day Moving Average (DMA) and the shorter-term 10-DMAs and 7-DMA are clustered. Most MA (moving average) Crossover systems are signalling buy. The next important support is 5,565-5,585, where the last intermediate bottom came in late June.

The historical volatility has been high and it's liable to remain so. The CNXIT Index has been a clear outperformer due to the falling rupee. IT majors such as TCS and HCL Tech are both trading at new 52-week highs. Their continued bullishness could contribute crucially to a rising Nifty and also provide a hedge if the Nifty's trend reverses.

The Bank Nifty is testing resistance at 11,700-11,800 levels. The upside here will partly depend on views about the RBI's next credit policy. As of now, the market seems optimistic and a surge past 11,850 could take it till 12,200. But if support at 11,450 breaks, it could slide all the way back below 11,000 again. However, the credit policy is only due early in the next settlement.

Option analysis suggests the market is in overbought territory, which could mean a correction this week. The Nifty's put-call ratio is at 1.8 for July options and at 1.6 for the three-month series. Anticipated high volatility has meant that expiry effects are not so pronounced yet, although there's only eight sessions left.

Option chains suggest huge resistances at 6,000-plus because the call chain's open interest peaks there with adequate liquidity until 6,200c. The call premiums run at 6,000c (84), 6,100c (36) and 6,200c (11). The put chain in contrast has very high liquidity down till 5500. The put premiums run at 6,000p (55), 5,900p (27), 5,800p (14) 5,700p (8), 5,600p (5), 5,500p (3.5). The index is close to 6,000. A straddle of long 6,000c (in-the-money) and long 6,000p would cost 140 with breakevens at about 5,860 and 6,140. Be prepared for a swing of at least this much in the next four sessions.

A bullspread of long July 6,100c and short 6,200c costs 25 and pays a maximum 75. A bearspread of long July 6,000p and short 5,900p costs 27 and pays a maximum 73. The bearspread is closer to money. Both these spreads could be struck. The combined long-short strangles with these positions has an adverse risk:reward ratio with a cost of 52 and maximum payoffs of 48.

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