Short term correction likely

Market still close to its all-time high of Nifty 6,869 and there could bea big surge if the BJP comes to power with stable coalition

The market has reacted through four of the past fivesessions and the global cues are looking a little weak. However, option premiums are still running very high and there is an undercurrent of optimism.

The market is still close to its all-time high of Nifty 6,869 and there could bea big surge if the BJP comes to power with the stable coalition. If theelectoral results aren't so clear-cut, there could equally well be a steepcorrection.

The last two weeks of the May settlement are verylikely to see extreme volatility. Domestic institutions have been net sellersthrough April while FIIs have been net buyers and so has retail.

The USDINR hasbeen ranged between 60-61. Worries about quality of Q4 earnings have surfacedon the fundamental side.The Nifty is holding out above support at 6,700.

TheBankNifty is hovering around the 12,900-13,000 levels. Any major impetus to thebull market would have to include the Bank Nifty. The trader could hold abullspread in the Banknifty with a long 13,500c (424) and a short 14,000c (263).The cost is 181 and the possible payoff is 319.

The Nifty has some support at every 50-ptinterval but the wide range of 6,350-6,850 is new territory and that means it'sdifficult to make predictions about possible correction levels. Going byelectoral history, a swing of 5 per cent or more on May 16 itself and a move of 10 per cent by May 29, is perfectly possible.

Conventional technical signals and fundamentals don'tmatter at the moment and even the fear of a poor monsoon is not a majorshort-term factor. Obviously, the long-term and medium-term trends are up,while a short-term correction seems to be in force. The May Nifty option chain and the three month Niftychains offer several signals worth noting. Premiums are massive on both thecall and put side of the chains.

The May Nifty call chain has large openinterest at 7,000c, 7500c and 8,000c. The put chain has high OI at 6,500p and alsoat 6000p but not too much OI below 6,000. Trader expectations mostly range fromabout 6,000 to 8,000 - that is, about 12 per cent down and 18 per cent in thenext three weeks.

The Nifty's put-call ratio for May, June, Julycombined is at 1.12 and the May PCR is also at 1.1 This is a mildly bullishvalue and an improvement on earlier highly over-bought signals.If the DIIs turn net buyers while FIIs maintain theircurrent bullish stance, the market will be forced up sharply.

The oppositescenario, FIIs turning sellers while DIIs remain sellers, could lead to adevastating correction. Either an only-buyers or only-sellers situation mayresult post-election. Until May 16, the market isnot likely to gain or lose major amounts unless there are unexpected newsdevelopments. There has been some decay in option premiums since thenew settlement started.

Option selling may still be possible but it no longerlooks an entirely safe strategy. If you sell, set strict stop losses and beprepared to book profits quickly.Given volatility expectations, deep bullspreads and bearspreads on the Nifty arepossible.

A long May 6,900c (175) and short 7,000c (139) costs 36 and pays amaximum 64 with the spot Nifty traded at 6,720. A long May 6,600p (189) and ashort 6,500p (151) costs 38 and pays a maximum 61. Neither ratio is veryattractive and strangles offer negative risk:return ratios anywhere within 300 pts of the money.