Key Nifty levels to watch are 5,820 & 5,965

The market has been a little bearish heading into the Reserve Bank of India’s (RBI) mid-term review. But the breakout still seems valid. The key levels to watch are 5,820 and 5,965. A drop below 5,820 (the 52-week high before the November breakout) would mean a reversal in the intermediate trend. So, this is a crucial support level. A drop below 5,775 would signal a failure of the November breakout. The most recent 52-week high is 5,965 and if the trend remains bullish, this mark should be beaten.

The Nifty must be rated bullish in the long term. The short term trend is uncertain. The intermediate trend is also puzzling. Successive new highs have been established since the breakout but the Nifty has also tested support just above 5,820. It's likely any clear trend established in December will persist through early 2013.

Volumes remain quite good. The FII attitude stays net positive. DIIs remain net sellers. December has been volatile so far for currencies. The dollar hardened till near the 55 level. It could swing between 53 and 56 by month-end. The fiscal cliff and how it’s dealt with will be a key factor.

The Bank Nifty has also hit successive highs and given its high-beta relationship with the Nifty, the direction of the financial index is crucial. This is where the RBI review might make a big difference. The market expects another CRR cut but it no longer expects a rate cut in December.

If the RBI does cut policy rates, a zoom till 13,000 may be on the cards. However, if the RBI leaves rates and CRR untouched, a drop back till 12,000 is also possible. The CNXIT has been bearish. It could be a hedge if the overall market corrects along with USD hardening.

Traders should remain braced for a big move in the last 10 sessions of the settlement. The favoured direction is still bullish and the premiums reflect that. But any correction below 5,775 could be quite deep. The December Nifty put-call ratios (PCR) are at about 1.2 while the three-month PCR is around 1.1. This is still in a healthy zone but weaker than a week ago.

The option chains show that trader expectations have narrowed as expiry comes closer. The December call chain has high open interest (OI) between 5,900c (49), 6,000c (17) and 6,100c (5) with a huge OI spike at 5,900c. The put chain has high OI from 5,500p (2.5), 5,600p (3.5), 5,700p (8), 5,800p (22), with a more even OI distribution.

Since the underlying index is at 5,860, puts and calls are more or less equidistant from money. But premiums are skewed heavily towards calls. The Nifty futures is trading at a premium of around 30 to the underlying index. The maximum short-term expectations of the next four sessions would be 5,700 and 6,025.

On-the-money return to risk ratios are okay for bullspreads and attractive for bearspreads. The bullspread of long Dec 5,900c (49) and short 6,000c (17) costs 32 and pays a maximum of 68. The bearspread of long Dec 5,800p (22) and short 5,700p (8) costs about 14 and pays a maximum of 86.

Strangles will have unbalanced payoffs although these are zero-delta. A near-the-money long 5,900c, long 5,800p, offset by a short 5,700p and short 6,000c costs 46 and pays 54. This could be worth taking since breakevens are close, at 5,754, 5,946.