Long-term trend is still up

The breakout to a new 2010 high (Nifty 5,403) on Monday was nominal in terms of actual advance over the previous high (5,399 of April 7). It does confirm the long-term trend is still up. So it seems quite a positive signal.

If the breakout is valid, it should lead to a move to 5,525-5,550 by the end of settlement (July 29). The intermediate trend has been up since late May, this is week 8. An intermediate trend can last anywhere between 6 and 12 weeks, so this could mature and reverse soon. It could also register net gains for another 3-4 weeks and that’s the optimistic reading.

The pessimists will interpret the chart signal as a bearish double-top with strong resistance at the 5400 level. If that’s the case, a short-term downtrend could be triggered by profit-breaking and take the index down to support at 5,250. This would be followed by successively lower tops and bottoms.

Most background signals are positive. Breadth is good. Volumes are picking up. The subsidiary indices, such as the BankNifty and the CNXIT are looking bullish. The institutional position is cautiously positive with strong FII buying in July over-balancing moderate domestic institutional selling.

In the derivatives segment, open interest has continued to rise. The Nifty put-call ratio is solidly bullish. Carryover also seems to be steadily increasing. Nevertheless, derivative traders should be prepared for a downturn as well as another push North.

In the perspective of the next five sessions, derivative traders should be focussed on the 5,200-5,550 range. In the longer-term of settlement, they should cater for an upmove till 5,600 or a drop till around the 5,075-mark. Volatility is likely to rise.

Spreads close to money have acceptable risk:reward ratios. The long July 5,400c (65 premium) and short 5,500c (26) costs 39 and pays a maximum of 61. The long July 5,300p (50) and short 5,200p (29) costs a net 21 and offers a tempting maximum return of 79.

Given a chance of rising volatility, strangles such as a long 5,500c and long 5,200p are possible if the trader is prepared to wait until settlement. This long strangle would cost 55 and it can be offset with a short 5,100p (9) and a short 5,600c (16). The combined position costs a net 30 and has breakevens at 5,170 and 5,530. It pays a maximum of 70 on a one-sided move to the limit.

Also, focus closely on the earlier recommendation of a Long Call butterfly with a long 5,300c, two short 5,400c and a long 5,500c. This cost 18 when recommended. It can be reversed for a net inflow of 22 and a small profit. Above 5,400, this position would start losing value.