A short-term correction seems to be in force

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Fears of a weak monsoon and tensions in the Ukraine have led to a minor correction in the past two sessions. The market is still close to all-time highs. The Nifty tested a new high at 6,869 in the past few sessions. If the Bharatiya Janata Party (BJP) does come to power with a stable coalition, there could be a huge surge in the last two weeks of the May settlement. If the electoral results aren't so clear, there could equally well be a steep correction.

Option premiums are pretty high and the VIX is also up, signalling nervousness about the coming wave of volatility. Domestic institutions have been net sellers through April, while foreign institutional investors (FIIs) have been net buyers and so has retail. The dollar-rupee has ranged between 60 and 61. The fourth quarter (Q4) results have, so far, been on the better side, with the information technology majors doing especially well.

The Nifty is holding out above support at 6,750, near historic highs. The Bank Nifty has edged up and could provide major impetus to the next upmove. The trader could hold a bullspread in the Banknifty with a long 13,500c (486) and a short 14,000c (301). The cost is 185 and the possible payoff is 315.

The Nifty has some support at every 50-point interval but the wide range of 6,350-6,850 is new territory and that means it's difficult to make predictions about possible correction levels. By electoral history, a swing of five per cent or more on May 16 is perfectly possible.

Conventional technical signals and fundamentals don't matter at the moment and even the fear of a poor monsoon is unlikely to completely derail this run. Obviously, the long-term and medium-term trends are up, while a short-term correction seems to be in force.

The May Nifty option chain and the three-month Nifty chains offer several signals worth noting. Premiums are massive on both the call and put side of the chains. The May Nifty call chain has large open interest (OI) at 7,000c, 7,500c and 8,000c. The put chain has high OI at 6,500p and also at 6,000p but not too much OI below 6,000. This means trader expectations mostly range from 6,000 to 8,000 - that is, 12 per cent down and 18 per cent up in the next four weeks.

The Nifty's put-call ratio (PCR) for May, June and July combined is at 0.1 and the May PCR is at one. This is a neutral value. Until last week, the PCR was below one, signalling a very overbought market. Enough put OI has been generated since to balance the expectations.

If the DIIs turn net buyers while FIIs maintain their current bullish stance, the market will be forced up sharply. The opposite scenario, FIIs turning sellers while DIIs remain sellers, could lead to a devastating correction. Either an only-buyers or only-sellers situation may result post-election. Until May 16, net gains seem a little more likely.

As mentioned, the BankNifty is bullish and high-beta. It could run up till 14,000 or beyond before May 16. The IT index would be a good hedge if the rupee weakens for some reason, such as FII profit-booking.

There has been some decay in option premiums since the new settlement started. Option selling might still be possible but no longer looks an entirely safe strategy. If you sell, set strict stop-losses and be prepared to book profits quickly.

Given volatility expectations, deep bullspreads and bearspreads on the Nifty are possible. A long May 6,900c (204) and short 7,000c (161) costs 43 and pays a maximum 57, with the spot Nifty traded at 6,760. A long May 6,600p (147) and a short 6,500p (116) costs 31 and pays a maximum 69. Neither ratio is very attractive.