Intermediate trend may be reversing to bearish

More tightening by the Reserve Bank of India (RBI) abruptly terminated a rally. The Nifty dropped from a high of 6,093 to 5,962 before it found support. The rupee strengthened to near 59.1 against the dollar. The RBI's actions have removed liquidity from a low-volume market.

The foreign institutional investors (FIIs) cut back scale of operations in July and perforce, so have domestic institutions. Optimists hope the RBI will quickly reverse these policy measures and perhaps, cut rates on July 31. But there looks to be little chance of that.

The Nifty's current support is 5,965. If that is broken, the next support is near 5,900. The intermediate trend may be reversing to bearish after four weeks of bullishness. Chart patterns are not definitive yet. But the advance-declines ratio is negative, volumes are low and broader indices have lost more ground than the Nifty.

The upside to beat to maintain a bullish pattern is 6,093. Below 5,900, the next key supports are in the 5,825-5,850 zone. That's where the 200-Day Moving Average (DMA) is located. The index has dipped below the 200-DMA several times in 2013 and recovered each time. This time around, if 5,850 is broken, the next level to watch is 5,550-5,600.

Volatility is likely to stay high through August. Low volume trading usually leads to higher price volatility. Also by tightening liquidity, the RBI may have created a potential danger. If there is heavy FII selling in debt or equities, domestic institutions would not be able to take the trades without a deep correction. The CNXIT index has been a outperformer. IT majors such as TCS, TechM and HCL Tech are trading at 52-week highs. Continued bullishness here could be a critical hedge. However, if the rupee does strengthen, IT stocks will see fractured momentum.

The Bank Nifty has taken a hammering. It's down by over 1,000 points in the settlement and it could fall further. There is a chance that support at the 52-week low of 9,800-9,825 will be tested, especially if the credit policy is disappointing.

Apart from potential short futures positions, there is reasonable liquidity in the Bank Nifty option chain. A tempting position is a bearspread of long Aug 10,500p (245) and short 10,000p (125). This costs 120 and it could pay over thrice that. Individual bank stocks also seem ripe for shorts.

The Q1 results have been lukewarm. Dollar earners in IT and pharma are doing well and so are FMCG. Otherwise, most sectors have struggled. Financials, metals, realty, construction and capital goods have all seen multiple 52-week lows.  Option analysis is inaccurate close to expiry. Rollover hasn't been high yet. The Nifty's put-call ratio is at 1.8 for July options and at 1.5 for the three-month series. The August call chain suggests huge resistance at 6,100-plus, with liquidity until 6,300c. The August put chain has maximum liquidity at 5,900p, with liquidity down till 5,500p.  The index is close to 6,000. A straddle of long July 6,000c (25) and long July 6,000p (22) has breakevens at 5,953 and 6,047. Settlement may stay within those limits but breakouts today could be till 5,900 or 6,100.

A bullspread of long Aug 6,100c (86) and short 6,200c (48) costs 38 and pays a maximum 62. A bearspread of long Aug 5,900p (71) and short 5,800p (47) costs 24 and pays a maximum 76. The combined long-short strangles of these positions has an adverse risk:reward ratio with a cost of 62 and maximum one-way payoffs of 38.