Expect a breakout in May settlement

There has been little substantive change in the market trend since the April settlement last Thursday and indeed, in the past five weeks. Support has held just above the 200-day moving average (DMA), while the upside has been, limited by resistance above 5,300.

The key level on the downside remains the low of March 28, at Nifty 5,135. The market would need to drop below 5,135 to confirm a long-term bear market. The key high is 5,379, the high of April 3. A rise above 5,379 would indicate an end to the bearish intermediate trend.

While the market continues to range-trade between 5,135-5,379, the trader can only watch for breakouts without over-commitment. Breadth indicators remain somewhat negative. Volumes have been low. Foreign institutional investors (FIIs) have been net sellers in the past month. A long USDINR still looks tempting.

In the short term, support between 5,175-5,225 has been tested multiple times without breaking. This is a critical zone above the 200-DMA. The daily high-low volatility has been low as well. Any breakout outside 5,135 / 5,380 will probably come with higher volumes and it could lead to a move of 200-250 points, with targets of either 4,900 or 5,600. Among subsidiary sectors, the CNXIT went bearish before making a partial recovery. The CNXIT could drop back to test support at 5,650-5,750 if it goes bearish again. However, a weak rupee may provide some support. The Bank Nifty is high-beta with respect to the Nifty. It has done a little better than the overall market in the past month, probably due to the rate cut. The key level of support would be 9,950. The Bank Nifty could lead a possible recovery if it bounces above 10,700. Among other sectors, PSUs in general, look under pressure.

The Nifty Put/ Call ratio (PCR) has improved in the May settlement. Overall, it’s about 1.3 and the May PCR is 1.2. Option chain analysis isn’t too useful yet, due to post-settlement considerations. But call open interest (OI) is clustered between 5,300 and 5,600, while put OI is clustered between 5,000 and 5,200. So, traders are expecting moves of anywhere between 5,000 and 5,600.

It makes sense to bet on higher volatility and a breakout in the May settlement. This pattern of range trading cannot continue much longer. The low intra-day high-low ranges have also meant that options a little far from money are cheap. So, betting on a breakout could fetch handsome rewards.

The bullspread at the money would be a long May 5,300c (86) versus short 5,400c (47). This is reasonable, with a cost of 39 and a maximum payoff of 61. One step away, a bullspread of long May 5,400c (47) and short 5,500c (22) costs 25 and pays a maximum 75. At the money, a bearspread of long May 5,200p (76) and short 5,100c (47) costs 29 and pays a maximum 71. This is a pretty decent risk-reward ratio. Further away a long 5,100p and a short 5,000p (27) costs just 20 and pays 80. A trader betting on breakouts can combine the above spreads to create long-short strangle positions. Combine a long 5,400c, long 5,100p, short 5,000p and short 5,500c for a net cost of 44. This pays a maximum of 56 with breakevens at 5,444 and 5,056.