Nifty could test 7,850 levels

The market went into a sharp downtrend. Weak domestic macroeconomic data coincided with global currency uncertainty and a statement from the Reserve Bank of India (RBI) Governor ruled out a rate cut in the next policy review. The settlement next week is likely to see high volatility.

The indices hit highs on September 8, with the Nifty touching 8,180. Since then, it's been a slide. The by-election results will hurt the Bharatiya Janata Party (BJP). Retail sentiment has gone negative, leading to weak advance-decline ratios. Volumes have dipped with major indices. The net institutional attitude has been negative in five-six sessions with both domestic institutions and foreign institutional investors (FIIs) being sellers.

The market has moved up so much since the May 16 general election results (when it was at Nifty 7,200) that calculating possible retracement levels is difficult. The 200-day moving average is way below at 6,865. The Nifty had moved up 650 points between its most recent low of 7,540 in mid-August and its all-time high of 8,180.

Fibonacci calculations suggest it could land at support around 7,940 (where it is), or fall till 7,850, 7,775 or 7,700. Below 7,700, there would be worries about the intermediate trend and the long-term trend may come into question.

The Bank Nifty remains a key driver and it could lose more ground than the overall market. The RBI Governor's recent statements ruling out possible rate cuts will add to the pressure on bank stocks. The Bank Nifty could find support in the 15,700 zone. If the index drops below 15,600, it could slide till 15,000.

The dollar has risen above Rs 61 and could run up further if FII selling continues. There will be some end-of-month currency pressure as the oil majors run up their import bills too. A long dollar-rupee seems reasonable. Defensive sectors could come into play if the rupee loses ground.

Settlement comes up next week and expiry effects are visible with option premia having dropped far from money. There is a good chance this is a mispricing by the market. The Nifty could easily see a move of three-four per cent in seven sessions and that would be 250 points away from current levels.

I will be tempted to go wide and buy options distant from money though the close-to-money spreads are also offering decent risk-reward ratios. The Nifty's put-call ratio (PCR) is at 0.9 for the September series and that's bearish. The PCR is above one - neutral territory for the three-month set.

The Nifty Call chain has massive open interest (OI) at September 8,200c, which would be likely upper limit on a bounce. The Put chain has a lot of OI down till 7,500. The spot Nifty index closed at 7,933, with the futures at 7,956.

A close-to-money bullspread of long Sep 8,000c (44) and short 8,100c (17) costs 27 and pays a maximum of 73. A CTM bearspread of long Sep 7,900p (38) and short 7,800p (15) costs 23 and has a maximum payoff of 77.

A wider bullspread of long 8,100c (17) and short 8,200c (7) costs 10 and pays a maximum 90 while a long 7,800p (15) and short 7,700p (6) costs nine and pays a maximum 91. Combining these two wider spreads, we get a long 7,800p, long 8,100c, short 7,700p and short 8,200c. This costs a maximum 20 with a maximum payoff of 80, with break-evens at 7,780 and 8,120.