Lower lows, dropping momentum point to an intermediate reversal

T he past three sessions confirmed that a downtrend of some description is in progress. A succession of supports between 6,000 and 6,150 were broken in this period. A pattern of lower highs and lower lows has been established with a rebound from support at 5,975 on Monday.

Volumes remain pretty high in both cash and derivatives segments. There was a rebound late into the session on Monday and that led to a pullback till 6,075 levels. However, the movement looked very much like traders closing shorts and booking profits. Declines outnumbered advances.

The FIIs continue to be net buyers but their enthusiasm has moderated in terms of volumes. The domestic institutions remain steady net sellers and retail players are increasing their selling. The Coal India IPO is also certainly creating some pressure.

The lower lows and dropping momentum suggests that this is an intermediate reversal If so, we could expect further net losses through the settlement with a likely correction till the 5,800-level. A prudent trader cannot quite rule out a sudden bounce, on short-covering or otherwise, till 6200+ .

The CNXIT and Bank Nifty have led and outperformed the Nifty through the past 18 months. The Bank Nifty has been under major pressure in the past few sessions and looks worth a short. It could easily slide below the 12,000 level. The CNXIT was hit after Infosys delivered good results and flat guidance. It has since recovered but it is likely to be hit again. A drop till 6,350 is on the cards.

The Nifty's put-call ratio remains in a normal-bullish range. The VIX has risen however, and if we discount the expiry effect, close to money premiums are high. There is a higher chance of net losses in the rest of the settlement, and losses would be guaranteed if the FIIs do start selling.

There's been a lot of intra-day option premium swings and traders must stay alert to the possibility of reversing any option spread if there's a quick buck to be made. Option spreads close to money are still offering reasonable risk:reward ratios.

A long 6,100c (90) and short 6,200c (46) bullspread costs 44 and offers a maximum return of 56. A long 6,100p (67) is in-the-money and it can be laid off with a short 6,000p (38) for a net cost of 29 and pays a maximum of 71. The bearspread is obviously more attractive and it has an excellent risk:reward ratio.

Given the possibility of a potential bounce, an interesting two-way position is a combination of long strangle of long 6,200c (46) and long 6,000p (38) with a short strangle of short 5,900p (20) and short 6,300c (22). The net cost is about 42 and a move to either limit would be worth 58. Breakevens are at 6,242; 5,958. There is also every chance of gaining from both sides of this position if you find the right moment to reverse the positions.