Be wary of going short in Nifty

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The Nifty hit new highs. However, it also experienced some selling pressure, resulting in a minor correction. On Wednesday, April 5, the index hit a high of 9,273 but it had corrected down to below 9,200 by Monday (April 10).

The last week saw reasonable volumes and advance-decline ratios remained positive. However, while both overseas and domestic institutional investors remained positive, buying moderated. The dollar hardened a little as the FII buying abated. Retail investors also booked profits at above 9,225. This correction should have support at 9,120-9,150. That was the prior all-time high, established in 2016.

On the upside, the next target remains 9,300. If the correction does find support, it could move above 9,300 soon. Every trend-following system would still recommend staying long with a stop at around 9,100 or lower, at 9,050.

However , corrections could continue if there's adverse news on the global or domestic front. The index started moving North in late December from 7,900 levels. An intermediate correction could last four weeks or more, and a correction till 8,800 would be on the cards in an intermediate downtrend. The global attitude seems pro-emerging market. Changes in FII attitude could trigger a sell off.

The dollar has been sold down versus most world currencies since the latest Fed hike in mid-March. However, it has now bounced from close to Rs 64. Traders could consider going long on the dollar/rupee purely on technical grounds.

The Nifty Bank is trending at about 21,500 now. A long Nifty Bank (April 27) 20,500p (27), and long (April 27), 22,500c (14), costs roughly 41. This is near zero-delta with the "Bank" trading at 21,520. Three big trending sessions in the settlement could send either end of this long strangle into profit. A short (April 20) 20,500p (10) and short (April 20) 22,500c (9) could reduce the cost of the position to 22-odd without increasing risks. The respective long option would gain if a short option was hit.

Global triggers include Brexit, terror attacks, more US strikes in the West Asia, debates in the Indian Parliament and political developments in Turkey which has a referendum, and in France and Germany where elections are due. On the domestic front, GST is still a positive trigger. Results will also start to flow next week.

 
The VIX is under-pricing volatility at the current low levels. The April Nifty call chain has peak open interest (OI) at 9,500c and high OI at every strike until 10,000c. The April put chain has very high OI at every strike down to 8,000p, with peaks at 9,000p, 8,800p and 8,500p.

The Nifty is at about 9,185. The futures premium is low. The put-call ratio is standing around 1 which means that is neutral. A long April 9,200c (87), short 9,300c (42) costs 45 and pays a maximum of 55. This is about 20 points from money. A long April 9,200p (78), short 9,100p (45) costs 33 and this is in the money. It could pay 67.

Look at wider spreads. The long 9,300c (42), short 9,400c (16) costs 26, pays a maximum 74, and its 120 points from money. The long 9,100p (42), short 9,000p (25) costs 20 and its 80 points from money. A combination of these two spreads cost 46 and the breakevens are at 9,054, 9,346, with a maximum payoff of 54. The bearspreads have better ratios.

Any trend following system would suggest staying long in the Nifty futures, with a trailing stop set at about 9,100 points. Even if there's a correction, be wary of going short until and unless the index drops, combined to a negative advance-declines ratio, and strong volumes in losing stocks.

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