Market rally may continue till mid-May

A Bank Nifty trend-reversal could trigger a Nifty correction and rupee weakening, which would make IT look attractive again as a hedge

The market has been a trend-follower’s dream through March. It has hit successive all-time highs. The credit policy could lead to the uptrend becoming even stronger, or it could lead to bout of profit-booking and temporary reversal.

The consensus is that the Reserve Bank of India (RBI) will not touch policy rates or the cash reserve ratio (CRR). This would be mildly bearish in impact. A rise in rates or a tighter CRR would be quite bearish. A cut in rates or easing of CRR would be bullish.

The Bank Nifty is high beta. The financial sector (banking and other financials) has a large weight in the Sensex and Nifty. The Bank Nifty, which closed on Monday at 12,742, could swing till 12,000 or 13,500 if the RBI surprised. Otherwise, it should remain inside 12,350-13,100 over the next five sessions.

The bull run has been driven by foreign institutional investor (FII) money so, RBI policy will not have a direct impact on resources. However, selling on the part of FIIs could push the dollar-rupee up, till the 62-62.5 level. Conversely, more buying could push the rupee up, till 58.

A Bank Nifty trend-reversal could trigger a Nifty correction and rupee weakening, which would make information technology (IT) look attractive again as a hedge. The first set of full-year IT results will soon be available. Investor sentiment about IT is weak, given a strong rupee and pessimistic advisories from Infosys and TCS and a trend reversal here could be lucrative for a nimble trader.

Purely by technical analysis, it's impossible to set an upside target when the index is in an entirely new range. The rally has not yet seen widespread domestic participation, so retail or buying by domestic institutional investor (DII) could add more fuel. On the downside, the key support would be at the Nifty 6,400-6,425 level, where the historic highs were logged, prior to the March rally. Between 6,400 and 6,700, the index has moved too fast to generate strong supports and resistances.

Given that the entire rally has been driven by hopes of a favourable election outcome, and the results are due on May 16, the market could make net gains until then. The bulls who are long Nifty in the futures segment should probably keep a trailing stop-loss at 1.5 to two per cent below current price.

Obviously, it could also be derailed earlier by unfavourable news, either on the electoral or the geopolitical front. In the absence of adverse news, the rally should run till mid-May. After results, it will get stronger if the election results are seen as favourable. Or there will be a dramatic correction, as occurred in May 2004, when the election results disappointed bulls.

In the options segment, the high volatility has been reflected in a rising VIX and very high premia close to money. There is also imbalance. Calls are priced much higher than puts at the same distance from spot. The on-the-money 6,700c is priced at 151 while the OTM 6,700p is at 98. Despite imbalanced premia, the Nifty’s put-call ratio (PCR) is in a neutral zone of 1.1 to 1.2.

Traders should be braced for the Nifty to swing anywhere between 6,400 and 7,000 in the next 10 sessions. A long April 6,800c (84) and short 6,900c (47) costs 37 and pays a maximum 63. A wide bullspread of long 6,900c (47) short 7,000c (24). A long April 6,700p (97) and short 6,500p (62) costs 35 and pays a maximum of 65. The bearspread is on the money so, it's more tempting. Strangles would have to be set very wide at, for example, long 6,400p (24) and long 7,000c (24).