If the bear market is strong, rally will end below 7,600

A week of massive selling forced the major market indices down to 21-month lows. A sharp recovery on Monday looked like a rally driven by short-covering. The bears seem firmly in charge, especially since corporate results have been disappointing. Asian volumes should improve, since the Chinese New Year holidays are over. Perhaps the sentiment will also change if there are hopes centred on the Budget.

The major trend is clearly down. The Nifty reacted from a high of 7,600 on February 1. This was much lower than the prior high of 7,831 on January 5 and so it maintained a bearish pattern of lower highs. The acid test was the break of support at 7,250 and a fall below the prior 52-week low of 7,241 (January 20). The index bottomed at 6,869 on February 12. It has subsequently bounced to 7,162 on February 15. The crash therefore, established lower lows.

We can figure out points to watch for chartists. The first key resistance on the upside would be in the range 7,250- near the previous low. This will almost certainly be broken. However, if the bear market is strong, the rally should terminate below 7,600 (peak of February 1), maintaining a pattern of lower highs. A move beyond 7,600 setting up higher highs would be encouraging. On the downside, look for a fall below 6,869, for continuation of the pattern of lower lows.

The bear market has now lasted 11 months with a 24 per cent correction from the all time peak of 9,119 (March 2015). FIIs have been equity sellers since November 2015. Retail investors were gradually forced out of the market in late January and totally routed last week. Domestic Institutions remain net positive, but they have not stemmed the tide. A bounce till 7,600 levels could come quickly if this rally sustains. Even a bounce till 7,850 is possible. But, the Budget would have to break the mould to force the market up further. The market was quite disappointed by the 2015 Budget and global conditions have gotten worse since then. Adjunct reforms like GST appear impossible, given hardening political opposition.

The Bank Nifty has run weaker than the overall market and it remains high-beta. A long strangle with a long 14,000p (98), long 15,000c (62) is not zero-delta since the index is around 14,445. But, either end could be struck in one big session and four big trending sessions would mean 1,000-points swing in either direction.

The Nifty call option chain for February has ample open interest (OI) between 7,200c and 8,000c, with a big peak at 7,500c. The February put option chain has big OI peaks at 7,200p and 7,000p and high OI until 6,800p. Both the February put-call ratio (PCR) and the three month PCR are negative with similar readings of 0.82.

The Nifty closed at 7,162 on Monday. Near the money spreads are possible. Expiry effects are not yet very evident, probably because of the high volatility expectations. A bullspread of long February 7,200c (66), short 7,300c (31) would cost 35 and pay a maximum of 65 at about 38 points from spot. A bearspread of long 7,100p (64), short 7,000c (36) costs 28, with maximum payoff of 72 and this is 62 points from spot. These spreads could be combined. But, they are not zero-delta. The cost is also higher than the possible payoff. A long 7,000p (36), long 7,300c (31) makes more sense if you want a two-way cover. This can be offset with a short 6,900p(20) and short 7,400c (13). This costs 34, with breakevens at 6,966, 7,334.

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