Derivatives Strategies: Intermediate trend is bearish

The market has one phase of a sharp correction with a rebound on Monday. However, it’s possible that this is now an intermediate downtrend. A five session dip saw the Nifty find support at 9,685. This sets up a pattern of lower lows versus the previous low of 9,792 (July 18). The rebound hit selling pressure around 9,800 and the index closed at 9,794 on Monday.
 
On the upside, the mark to beat is the all-time high of 10,137. The correction led to a drop of 4.5 per cent, along with a big spike in the VIX and other bearish signals. The advance-decline ratio went negative until Monday when it went positive again. Volumes expanded during the period of selling. These are both negative signals.
 
The proximate trigger was the Sebi (Securities and Exchange Board of India) action against 331 so-called shell companies. This followed on the heels of a disappointing credit policy. Poor macro data and a gloomy Economic Survey (Vol. 2) also affected the sentiment. So far, the earnings season has seen more downgrades than upgrades.
 
Foreign portfolio investors (FPIs) have sold equity through August though they continue to buy debt. Mutual funds and domestic institutions remain net buyers but retail investors have also been selling. The rupee remains below Rs 64/$ due to FPI buying of rupee debt.
 
By definition, the long-term trend remains positive, given new highs. But the intermediate trend could be negative, given the lower low, and resistance at 9,800. The short-term trend bounced from support at 9,450 in late June to hit 10,137. This correction has broken several key supports. There’s support below current levels at every 50 points or so.
 

Taking a longer-term view, the Nifty moved North in late December 2016 from 7,900 levels. The length of this upmove (in both time and magnitude) indicates an intermediate correction could be severe. The first Fibonacci level is at around 9,250-9,300 and a dip till 8,850-8,890 may test the 200-day moving average.
 
Simple trend following systems would have closed out last week. Anybody who has opened long positions again would probably be taking stop-loss in the 9,625-9,650 zones. Put-call ratios remain in bearish territory.
 
The Nifty Bank also broke out to a new high at 25,200. It’s reacted down to 23,825 on Friday before pulling above 24,000 again. The August settlement is long and a swing below 23,000 or till 25,500 could occur if there are just three big trending sessions in either direction. A strangle of long August 31, 25000c (46), long August 31, 23000p (53) is not zero-delta. But, either side of this strangle could be hit. This position is relatively cheap. It can be offset with a short August 24, 25,000c (21), short August 24, 23400p (49). This is not a calendar spread since all the strikes differ. But, the long options will gain if the short strikes are hit.
 
The August Nifty call chain has peak open interest (OI) at 10000c and high OI until 11000c. The August put chain has very high OI at 9500p, with high OI till 9000p. The Nifty closed at 9794 on Monday ahead of Independence Day. The 9800c (114), 9800p (100), straddle would cost 214, with break-evens near 10015, 9585.
 
A bullspread of long August 9900c (64) short 10000c (33) costs 31 and pays a maximum 69. This is 105 points from money. A bearspread of long August 9700p (67), short August 9600p (46) costs 21, pays a maximum of 79 and is 95 points from money. These spreads could be combined. The resulting position is almost zero-delta. It would cost 52, with breakevens roughly at 9648, 9952. One side is very likely to be hit.