If market corrects, Nifty may drop to 8,200

The market continued to register new highs with the Nifty pulling above 8,600. However, global markets had weak cues on Monday. This could have some impact on Indian sentiment. More than any external influence, however, there is a degree of caution ahead of the Reserve Bank of India (RBI)'s policy review on Tuesday.

The equation seems fairly simple. If the RBI cuts rates, or the RBI governor makes dovish noises, the market will continue to climb. The Bank Nifty will outperform the broader market and so will non-banking financials. But here are no benchmarks for judging upside resistances and targets since we are in new zones.

If there's a correction, it's unclear if there will be support/resistance in the range between 8,200 and 8,600, since that zone has only been traded very recently. Below 8,200, there are reliable support levels at 8,150-8,200. For reference, the 200 daily moving average of the Nifty is more than 1,200 points below current trading levels and that makes it look like an over-extended rally. The current high is 8,623 and moves beyond that would confirm the trend stays strong. If the market sees a correction, a drop till 8,200 is entirely possible since a correction could run into the traditional end-of-year pullback from foreign institutional investors (FII). On the global front, the dollar continues to harden against euro and yen and the rupee has also dropped below 62 (against the dollar). China's equity markets are falling despite a recent rate cut. FII buying continues to be the driver for this rally in India. The FIIs bought close to Rs 11,000 crore in November, but they were net sellers on Monday. Domestic institutions have been net sellers through November.

If the central bank doesn't cut rates, reform bills passing through the winter session of Parliament could keep the trend up. Assembly election results could also be a news-based trigger for rallies or corrections, depending on the Bharatiya Janata Party's performance.

Despite the consensus, some are hoping for a rate-cut. If this happens, it could push the market into a new orbit. The dollar-rupee equation remains well-correlated to FII flows, but there is evidence that the RBI is intervening regularly to keep the rupee in a desired band.

The outperforming sectors include banking and finance and these could be hit really hard in a correction. Traditional defensives such as fast-moving consumer goods, pharma and information technology have under-performed. The Bank Nifty would have to be a major driver. It could hit 19,000 -plus and even target 20,000 if there's a cut. Or it could drop back below 18,000. A strangle of long 18,000p (230) and long 19,000c (170) could keep big swings covered. The Nifty's put-call ratios (PCR) have dropped into the danger zone. The three-month PCR is at 0.96, while the December PCR is at 0.92. Anything below 1 is bearish. The December Nifty Call chain has massive open interest (OI) peaking at 8,500c to 8,800c, though there is ample OI till 9,000c. The December Put OI peaks at 8,500, but there's another bulge in OI at 8,000p and ample OI till 7,500p.

The spot Nifty closed at 8,556. A bullspread of long December 8,700c (58) and short 8,800c (29) costs 29 and pays a maximum of 71. A bearspread of long December 8,500p (68) and short 8,400p (42) costs 26 and has a maximum payoff of 74. The bearspread is much closer to money. A trader looking for a strangle could take this set. A combination of long 8,700c, long 8,500p, short 8,800c and short 8,400p costs a maximum 55 and pays a maximum 45 with break-evens at 8,445, 8,755.