A breakout will give definite direction

There’s been very little change in values since last week and Monday’s session was token, in terms of volumes, due to the nationwide bandh. So, the Nifty remains stuck inside a very narrow range with no clarity as to direction of the intermediate trend.

As of now, there is support at 5,200-5,250 and resistance above 5,325. Any breakout should lead to a 100-125-point move, till either 5,075-5,100 or 5,400-5,425. If the intermediate trend is still positive, we should see net gains over the next three-four weeks. But we’ll have to wait for a breakout to define the direction.

Open interest (OI) has continued to rise, even during Monday’s session where just about Rs 35,000 crore of F&O volumes were registered (about a third of normal). Institutions have been practically absent in the past two sessions. The CNXIT has been nearly neutral, or mildly positive, in outlook but apparently bounded by resistance at 5,950-6,000. The BankNifty has been distinctly nervous and it could see a major downturn if the RBI punches in another rate-hike. However, it could also rebound on the absence of bad news.

 

In the perspective of the next five sessions, derivatives traders should remain focused on the 5,200-5,400 range, while catering for a potential breakout till 5,075 or 5,425. The Nifty put-call ratio for July remains at 1.35 in terms of OI. That’s bullish. It would be a risk to take bullspreads further from money, despite the settlement being some distance away on July 29. Bearspreads close to money have good risk to reward ratios.

A long July 5,300c (premium 77) versus a short 5,400c (36) costs 41 and pays a maximum of 59, which is acceptable but not great. A long 5,400c and short 5,500c (13) costs 23 and pays a maximum of 77. A bearspread of a long 5,200p (88) and short 5,100p (60) costs 28 and pays a maximum of 72.

While the CTM bearspread has a good risk to reward ratio, strangles would require moving away to a long 5,400c and a long 5,100p with a gross cost of 96. This is excessive. Also, even if you are bullish, the 5,400c-5,500c may seem unlikely to be hit in the short-term, though it will gain somewhat if the market rises. An alternative is to take a long Nifty future with a stop-loss at 5,200.

One way to exploit moderate positive movement is a long-call butterfly. We’d made an earlier recommendation of a butterfly with one long 5,300c, two short 5,400c and a long 5,500c. This costs around 18 ((neglecting brokerage), which is the maximum loss. The butterfly would give a maximum return of 82, if the market moved till 5,400. It beats bullspreads across the entire 5,200-5,400 range.