Credit policy could lead to breakout

The market has now range traded for the last four weeks. Perhaps the credit policy will provide an impetus for a breakout. The short-term support for the Nifty is between 5,625 and 5,675, with short-term resistance at 5,700-5,725 and further resistance all the way till the 52-week high of 5,815.

In the past four weeks, (ignoring the flash crash), the market has traded between 5,625 and 5,750. The next five-seven sessions are news-heavy and thus, could induce breakouts beyond 5,815, or breakdowns below 5,625. Either move could result in a swing of 200 points, till 5,425 or 6,000.

The long-term trend is bullish with the Nifty well above the 200-day moving average. A fall below 5,610 would indicate a bearish intermediate trend. Volumes remain reasonable. The attitude of foreign institutional investors (FIIs) continues to be net positive and domestic institutional investors remain net sellers. The USD is testing resistance at 53.80 and it could move till 54.50 if the market trend weakens and/ or FII attitude turns bearish.

The overall corporate performance in Q2 will be clearer in another 10-15 days and impact is likely to be stock-specific. But the credit policy on Tuesday and the outcome of the US elections next Tuesday is more likely to have a broad impact in the near future. The CNXIT could be affected more than the overall market by the US elections – Romney is perceived as more business-friendly.

The Bank Nifty has key support at 11,200-11,300. This could be tested and broken if the credit policy is harsh. Traders expect a cut in cash reserve ratio (CRR) with policy rates staying unchanged. If the Reserve Bank meets expectations, the Bank Nifty will stay above 11,300 and probably range trade at 11,300-11,650. If policy rates are hiked, and/or CRR isn’t cut, the financial index could drop below 11,200 and perhaps, below 11,000. A rate cut might drive it up till 12,000 coming as a positive surprise.

The Bank Nifty is high-beta with respect to the Nifty. So, the major market index will move in the same direction as the financial benchmark. Traders should be braced for a big move sometime in November. The Nifty put-call ratios stand at a mildly bullish 1.1 (November 2012) to 1.2 (November 2012-January 2013).

Option chain analysis suggests traders are optimistic about an upside breakout but there’s also a lot of hedging evident. The November call chain has high open interest (OI) between 5,700c (93 ), 5,800c (51), 5,900c (24) and 6,000c (10). The put chain has high OI from 5,200p (6), 5,300p (9), 5,400p (16) , 5,500p (29), 5600p (53) and 5,700p (91).

Near-the-money return to risk ratios look reasonable for standard spreads. The close-to-money bullspread of long November 5,700c (93) and short 5,800c (51) costs 42 and pays a maximum (CTM) 58. The close-to-money bearspread of long November 5,600p (53) and short 5,500p (29) costs 23 and pays maximum 77. The CTM bearspread is more tempting.

A wider bullspread of long 5,800c (51) and short 5,900c (24) costs 27. A wider bearspread of long 5,500p (29) and short 5,400p (16) costs 13. A strangle of long 5,800c, long 5,600p, combined to a short strangle of long 5,500p, short 5,900c costs 51 and pays only 49, so it’s not that attractive. The trader would therefore have to take very wide strangles to exploit a breakout.