After 12 weeks, reversal may be imminent

The market has stayed range-bound, but it has shown signs of a potential down-move by repeatedly testing support between 5,375 and 5,410. This could be the beginning of a new intermediate downtrend for the Nifty. After values trended up for almost 12 weeks, a reversal may be imminent.

Volumes have picked up, however, in both cash and derivatives. Volatility has also increased slightly. The derivative volume expansion and volatility is not surprising, since we’re close to the settlement. But cash volume expansion is generally associated with higher prices and we’ve not seen signs of that.

There has not been a clear breakout yet and market direction is impossible to predict until there is a valid breakout. Any such breakout will be signalled by an initial move till either 5,275 or 5,550. Such a breakout is now highly probable due to the time factor and it’s more likely to be down than up.

The institutional attitude remains consistent. Foreign institutional investors (FIIs) are steady, but moderate net buyers and domestic institutions are steady net sellers. An alignment in attitudes, or a sharp increase in volumes from either FIIs or DIIs, is likely to be a a breakout.

The chances of a sharp correction in settlement week must be something that traders are geared for. In contrast to the time factor, the background signals remain neutral or mildly bullish. Breadth is nearly balanced with declines slightly ahead of advances in the past couple of sessions.

The key subsidiary indices, the BankNifty and the CNXIT, are both looking reasonably solid. Both have achieved predicted targets of new 2010 highs within the past week. They are seeing a correction, but neither looks especially weak.

The Nifty option scenario also seems mildly bullish. The put-call ratio is comfortable. But the option chain suggests there will be major resistance above 5,600 and major support at 5,200. Traders with a five-session perspective should be prepared for moves till these zones. The expiry effect is also evident with premiums dropping sharply far from money.

August spreads close to money have good risk-reward ratios. The long Aug 5,500c (20 premium) and short 5,600c (4) costs 16 and pays a maximum of 84. The long Aug 5,400p (51) and short 5,300p (24) costs a net 27 and offers a maximum return of 73. The bearspread offers better returns because it’s practically on the money, but the bullspread could generate huge returns if there is an upswing.

If the trader is willing to wait till settlement in the hopes of a breakout, strangle combinations also offer good risk-reward ratios – provided there’s a breakout. A long Aug 5,500c (20) and long Aug 5,300p (24) costing 44 can be laid off with a short 5,200p (11) and a short 5,600c (4). The net cost is 30 with breakevens at 5,270, 5,530 and a maximum return of 70.