5,850-5,900 a crucial level to watch out for

The market has seen a trend of slow but steady decline over the past six sessions. Almost all the breadth indicators have also started looking worse and the rupee has slid down. Poor macro-economic data today in the form of higher food inflation will affect sentiment more than the marginal rise in the IIP.

The ratio of advances to declines has turned negative. The Nifty has lost close to five per cent during this period and broken successive supports. There is strong support at every 50–point interval on the Nifty but the area to watch will be between 5,850-5,900, which is where the 200 Day Moving Average (DMA) is placed. If support in that zone is breached, a fall till the 5,650-5,700 area is likely. On the upside, there will be massive resistance above 6,200 and the market would have to move above Nifty 6,343 to re-establish a clearly bullish trend.

The long–term trend of the market would be called in question if the 200-DMA is broken. However, the Nifty has dipped below that point multiple times and made recoveries. It depends more on the view FIIs take and that in turn, seems to depend on what FIIs see as the likely schedule for tapering QE3.

The Bank Nifty contributed the most to the downturn. Financials are under-performing as the possibility of higher rates becomes a reality. Banking and financials together possess a very large weight and these shares are high-beta with respect to the Nifty. The inability of the financial sector to support the broader market could make further falls likely.

The BankNifty is now holding onto support at above the 11,500 levels. If that support breaks, it could fall by 500 points or more. A deep bearspread of long November BankNifty 10,500p (182) and short 10,000p (57) costs 135 and could gain a maximum 365 and this would be a reasonably cheap hedge against a big downturn. In the absence of thrust from the banking sector, other sectors have also been losing ground. The IT sector could provide some counter-balance but only if the rupee drops a little more.

The Nifty's put call ratios have dropped sharply and at 1.02, they are close to being bearish now. Short-term and medium-term averages are also starting to look bearish. The rest of November could be volatile if the FIIs change attitude and start pulling the market back up. Or else, this downmove could develop into a serious correction – we do have a historical trend of post Diwali selloffs.  

A trader should now stay braced for the Nifty to move anywhere between 5,600 or 6,300 in November and the downside looks more likely. Premiums on the Nifty futures to spot are still at about 30-40 points, which is normal at this stage.

A bullspread of long November 6,200c (42) and short 6,300p (19) costs 23 and pays a maximum 77 – this is more attractive than the on-the-money long 6,100c (80) and short 6,200c (42). A bearspread of long 6,000p (65) and short 5,900p (37) costs 28 and pays a maximum 72. A wider bearspread of long 5,900p (37) and short 5,800p (19) may also be tempting.  Wide strangles such as long 5,900p, 6,200c and short 5,800p and short 6,300c also look attractive. This offers a one-way return of 59 with breakevens at 6,241 and 5,859. It would exploit a deeper correction while hedging against a possible bounce driven by any improvement in FII sentiment.