Higher option premiums, VIX point to bearish sentiment

The market has several major events to weigh and discount in the short term. One major focus area is likely to be the RBI's policy review. The impact of global liquidity events is also likely to influence direction. The Fed's tapering of its quantitative easing and the European Central Bank's quantitative easing may influence inflows on the FII front and it will definitely impact currency rates.

Domestic political or judicial considerations such as the Coalgate verdict and the indictment of Jayalalithaa will probably feature in equations only as a third priority. Unless there are big surprises, Modi's US visit will have only long-term implications and those will be discounted last.

The general sentiment is somewhat bearish. There is anticipation that FII flows could slow or reverse in the short term. The advances-declines ratios are negative. Domestic retail sentiment may have been hit by the political scandals and the verdicts. FIIs have been sellers in the past few sessions and domestic institutions have been very moderate buyers.

The expectations from the RBI review is that status quo is likely to be maintained. The central bank is unlikely to cut rates despite falling inflation and equally and it is unlikely to raise these either. This would be a mildly bearish outcome because some diehard optimists are long in the hopes of an odds-against rate cut.

Option premiums have risen and so has the Vix. There is definitely a fear-factor in the market now. The Nifty has tested successive supports below 8000. The latest bounce was from the 7,850 level. If that support breaks, the index could slide till 7,775 or 7,700, going by Fibonacci-based retracement calculations. Dips below 7,700 could mean initiation of a strong intermediate downtrend. If the support at 7,850 holds, the upside is limited, until and unless the Nifty beats resistance between 8,125 and 8,175 and heads towards new highs.

The Bank Nifty remains a key driver and it could lose more ground than the overall market if there is a hawkish RBI policy. The RBI governor's recent statements are seen as hawkish and the consensus is very much for status quo. If RBI surprises, the Bank Nifty could slide till 15,000 or lower (on a hike) and it could move up past 15,750 on a rate cut.

The forex market is hard to call but October will be volatile. The Fed will taper, while the ECB will cut rates and increase money supply. This should lead to a harder dollar and a weaker Euro. The dollar-rupee may see a sharper movement in favour of the dollar. A short euro-rupee is also reasonable. IT and pharmaceuticals could come into play if the rupee does lose ground.

The Nifty's put-call ratios are bearish. This could mean a sharp drop. The Nifty's put-call ratio is at 0.9 for the three-month set and just below 1 for October series. The Nifty Call chain has massive open interest at October 8,200c, which is the likely upper limit on a bounce. The Put chain has a lot of OI down till 7,500.

The spot Nifty index closed at 7,959, with October Nifty at 8,008. A far-from money bullspread of long Oct 8,100c (68) and short 8,200c (37) costs 31 and pays a maximum of 69. A FFM bearspread of long Oct 7,900p (79) and short 7,800p (52) costs 27 and has a maximum payoff of 73. Combining these two contracts, gives a negative risk:return ratio, with a cost of 58 and max payoff of 42.