Volatility to stay high through August

The RBI left rates unchanged in the policy review and refused to give assurances as to when "temporary" tightening may be eased. The review was also gloomy in its prognosis. Though this was not unexpected, the market crashed. Optimists will hope the US Federal reserve will postpone the tapering of QE3, but even so FIIs may decide to exit rupee assets.

The FIIs have been steady sellers. The dollar has hardened again, partly due to demand from oil importers. The domestic institutions have also been net sellers and so have mutual funds. Though volumes are low, retail will find it difficult to match concerted institutional selling.

Breadth is poor, with advances far outnumbered by declines. A large number of stocks have hit 52-week lows. Results have been mediocre. There hasn't been much to excite long-term investors. The debt market has seen bond yields climbing.

This is early in the settlement and Nifty and Bank Nifty futures are trending at large premiums to the spot rates. Chances are futures' premiums will reduce sharply. The Nifty has dropped from a July high of 6,093 to 5,755. The Bank Nifty has dropped from 11,700 to 11,200. Both are well below respective 200 Day Moving Averages and in strong downtrends. Despite curbs on liquidity, the dollar has strengthened to 60.5. The RBI has relatively little ammunition to shore up the currency.

The Nifty's support is 5,750. If broken, it could test 5,565, where the index bottomed on the last correction. The intermediate trend is bearish, and the long-term trend may also be bearish given that the 200 DMA has broken.

However, we have seen the index bounce from below the 200 DMA several times. The upside to beat to maintain a bullish pattern would be 6,093. Before that, the market would have to push past the resistances in the 5,825-5,850 zone, where the 200 DMA is located.

Volatility is likely to stay high through August. The CNXIT index has been an outperformer. Continued bullishness here could be a critical hedge. The traditional hedges of FMCG and pharma may get some defensive investments but neither is doing well.

The Bank Nifty, with non-banking financials, looks weaker than most of the market because of its rate-sensitive nature. It is always high-beta with respect to the Nifty. There is a fair chance the bank Nifty could drop below the 52-week low of 9814 in five sessions. If so, it will pull the market. A Bank Nifty bearspread of long 10000put (223) and short 9500p (96) has good liquidity and an excellent risk:reward ratio. It costs 127 and it could pay a maximum of 373.

The Nifty has put-call ratios verging on the bearish at 1.05 or so. Though a bounce looks unlikely, a bullspread of long 5900c (68) and short 6000c (37) has a reasonable risk:reward ratio with a maximum payoff of 69 and a cost of 31. A bearspread of long 5700p (75) and short 5600p (47) costs 28 and could pay 72. Near-the-money options are too expensive to be attractive. Nifty strangles also look too expensive.