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A crisis in Iraq led to fears of crude supply disruptions and, as a result, oil prices jumped to 10-month highs. In line, the rupee weakened on fear that high crude oil prices could lead to a ballooning trade deficit and a larger fiscal deficit. The stock market uptrend broke after the Nifty hit 7,700 and the pullback has, so far, tested support at the 7,475-7,500 band.
There is support at roughly 50-point intervals across the range of 7,100 and 7,500. The indices climbed nine per cent in the past month (from the Nifty's 7,100 levels on May 15 to 7,700 on June 11) and profit-booking could lead to a significant pullback. The trend has been so rapid that it is hard to guess support-resistance levels in the 7,100-7,500 zone with accuracy. The first major congestion zone is 7,300-7,400.
Probably, the underlying sentiment is still positive and likely to remain so until the Budget. However, domestic institutions have been net sellers through 2014 and retail investors have booked profits in the past three or four sessions. The breadth has turned negative, with advances outnumbering declines in the past three sessions. Therefore, if foreign institutional investors turn net sellers, there might be a sharp correction.
The rupee's trend reversal could see some hedging in information technology (IT) and pharma stocks. The IT sector in particular could show its defensive, counter-cyclical strength if crude oil prices continue to move upwards. It is likely there will be a lot of volatility in the oil and gas sector; a review of the subsidy mechanism is expected and this will become urgent if crude and gas move up. Traders will have problems assessing valuations in oil & gas, given the negative news flow out of Iraq (and, to a lesser extent, Ukraine), and rumours of possible subsidy reviews that could have a positive effect.
The financial sector, especially banks, is looking weak because, apart from external factors, food inflation is feared if the monsoon is below-normal. A bear spread on the Bank Nifty might be tempting with a long 15,000p (230), offset by a short 14,500p (80). This could pay up to 350, versus a cost of 150.
As of now, the sensitive trend-following trading systems will be giving sell signals. The Nifty and Sensex have dropped below their 10-day moving average (DMA) and seven DMA, respectively. The short-term trend appears to be negative. The intermediate trend will need to beat 7,700 on the upside and stay above 7,350 on the downside.
The Nifty's June put-call ratio and the three-month put-call ratio are in bearish territory, at about 0.94.
The distribution of open interest across the June Nifty option chains makes a move of 7,000-8,000 look possible; this is a huge range to cover in less than two weeks. Expiry effects are not really visible yet - the India VIX could climb further.
On Monday, the Nifty held at 7,535. A long June 7,600c (57) and short 7,700c (26) costs 31 and pays up to 69. A long June 7,500p (51) and a short 7,400c (25) costs 26 and pays up to 74. Both risk-reward ratios are very reasonable. Also, these two close-to-money spreads could be combined for non-directional positions.
This long-short strangle combination costs 56 and has breakevens at 7,444 and 7,656. The strangle pair might be worth taking, despite the adverse risk-reward ratio. It is possible both ends of the positions could be in the black before the settlement ends.
