7,550 key support to watch out for

The new year began badly.

A crash in Shanghai triggered a sharp downtrend on global bourses. The Nifty broke down by two per cent and it's likely the downtrend will continue.  The trading pattern now looks bearish on all timeframes.

The Nifty topped out at 7,972 on January 1, a peak well below the index's 200-Day Moving Average (200-DMA) (around 8,190 at present).  On the downside, the support to watch is 7,550 where the last downturn ended on December 14, 2015. If the 7,550 support is broken, the index could register a new 52-week low, breaching the current low of 7,539. A breakdown would also imply a fall till around 7,200-7,250 before the Nifty hits decent support.

The global mood remains quite nervous. The drop in crude oil prices (and associated energy commodities) means threats of deflation. Projections of growth are being pared everywhere, including in India. The yuan is being devalued and so is the yen. The euro has seen a long period of weakening, with negative policy rates. The rupee is also under pressure against the dollar.  

Foreign institutional investors (FIIs) were sellers of rupee equity and debt through the past two months. It’s too early to judge their attitude in what is the new financial year for FIIs. Retail investors are net positive, albeit with reduced volumes. Domestic institutions are also net positive.

There is a chance that the market will trend sideways or even recover quickly if the government can get some positive traction going about the upcoming Budget. A move between 7,550 and 7,950 would calm the nerves even if it wasn't a positive signal. If there is positive sentiment about the Budget there may even be a rally as there usually is in February, based on Budget hopes.

The Nifty Bank Index looks more bearish than the overall market and the PSU banks are under very high selling pressure as is Axis Bank. As it happens, the PSU banks don't have much weightage in the Nifty Bank index but poor sentiment there could pull down the sector.  

The option trader may consider a Bank bearspread of long 16,000p (137), short 15,000p (25). This is about 600 points off the money, that is two big downtrending sessions. The return could be 887 on a cost of 113.  

The Nifty's put-call ratios remain bearish, hovering at around 0.93. The call chain for January has ample open interest (OI) between 7,800c and 9,000c, with a big peak at 8,000c, and lower peaks at 8,500c, 9,000c. The December put chain has big OI peaks at 7,500p and 8,000p (in the money) and excellent OI till 7,000p.

Option premiums have been quite low, which suggests the market is underestimating likely volatility, given the four weeks to expiry. This is probably a consequence of low volatility in the past few sessions of calendar 2015. The futures premium over spot is also very low, for this early stage of the settlement.

The Nifty traded at 7,791 on Monday, with the futures premium at about 15. A bullspread of long 7,900c (84), short 8,000c (49) would cost 35 and pay a maximum of 65, this is about 110 points from spot. A bearspread of long December 7,700p (87), short 7,600c (59) costs 28, with a maximum payoff of 72 and this is about 90 points from spot.

Both spreads could be combined for a set of long-short strangles which is almost zero-delta. That strangle set would cost 63, with a possible payoff of 37. This is not so attractive. Most traders will probably take a view favouring the short side.