Nifty level of 7,831 is crucial for rally to continue

The stock market looks nervous going into the Reserve Bank of India Policy review. Policy action is not expected from the central bank. But, China's slowdown seems to be getting worse; India's Q3 corporate results have been poor; there is worry about non-performing assets and the Foreign Institutional Investors (FIIs) continue to sell.

The major trend seems down, given that the Nifty reacted from a high of 7,600 on Monday (February 1). This is much lower than the prior high of 7,831 on January 5 and maintains a bearish pattern of lower highs. We can, therefore, expect lower lows too. The acid test would be a test of support at around 7,250 since the current 52-low is 7,241 (January 20).

So these are the points to watch for chartists. On the upside, look for a move beyond 7,831 and on the downside, look for a drop below 7,240. The support at 7,200-7,250 seems fairly good. The bear market has now lasted 11 months. The correction started from the alltime peak of 9,119 in March 2015.

Globally, crude saw a recovery, followed by further hammering. The China slowdown has hit metals as well. The threat of deflation looms over Europe and the Bank of Japan has just announced negative policy rates.

FIIs have been sellers of equity since November 2015. Retail investors have started selling in the last 10 sessions. Domestic Institutions remain net positive. A bounce till the 7,750-7,850 levels could come quickly since the Nifty fell almost vertically from 7,800 to 7,250. One obvious trigger could be an accommodative policy from the RBI. Another possibility is "garm hawa" in the form of Budget rumours, which could help drive the market up.

Consensus belief is that the central bank will do nothing until the Budget. The BankNifty has run weaker than the overall market, which is unusual. As of now, most public-sector banks are near respective 52-week lows and private bank, ICICI Bank, has taken a hammering on poor results.

My take is the Bank Nifty would fall if the RBI does nothing and makes a cautious statement. It could rise on a policy rate cut, or an optimistic statement from Raghuram Rajan. Neither seems very likely.

The BankNifty is trading around 15,350. A long strangle of long Feb 14500p (107) and long 16500c (47) is not zero-delta. But, the distance to either option could be crossed in three big sessions. The breakevens are at 14,345, 16,655. So four big sessions in February could turn a decent profit for the trader.

The Nifty call option chain for February has ample open interest (OI) between 7,500c and 8,000c and fair OI until 8,500c. The February put option chain has big OI peaks at 7,500p, 7,300p and 7,200p. There is a fair amount of put OI till 6,500p. The Feb put-call ratio (PCR) is mildly positive at 1.1 and the three-month PCR is bearish at 0.9. PCRs are unreliable just after expiry.

The Nifty closed at 7,556 on Monday. The 7,600c (102) is expensive and so is the 7,500p (99). A bullspread of long Feb 7,700c (59), short 7,800c (31) would cost 28 and pay a maximum of 72-this is about 145 points from spot. A bearspread of long 7,400p (69), short 7,300c (48) costs 21 with maximum payoff of 79 and this is 155 points from spot. These spreads could be combined. The cost is 49 with a max payoff of 51. It may be better to wait and take a position after the RBI policy review when there is likely to be a clear trend. The Bank Nifty has also hit new all time highs at 15,300-plus with a Friday surge to 15,750. The financial index could be crucial to the trend of the next few days. It looks mildly bullish in the context of the settlement and a bullspread of long 15,200c (330) and short 15,500c (200) has a good risk:reward ratio and is tempting.

The Nifty range between 6,850 and 7,250 is very new territory and there has not been much trading between 6,350 and 6,850 either. The Nifty PCR for May is at 0.95 with the PCR overall at 0.85. The distribution of open interest across the option chains makes a move of anywhere between 6,800 and 7,600 possible.

If DIIs turn net buyers while FIIs maintain their current bullish stance, the market will be forced up sharply. The opposite scenario, FIIs turning sellers while DIIs remain sellers, could still lead to correction.

A long May 7,300c (83) and short 7,400c (46) costs 37 and pays a maximum 63 with the spot Nifty traded at 7,263. A long May 7,200p (56) and a short 7,100p (28) costs 27 and pays a maximum 73. Both risk:reward ratios are reasonable. Combining the two near-the-money spreads offers a set of long-short strangles, which has an adverse payoff.