Nifty 9,685 a key level to watch

The market entered the second phase of a correction. It's possible that this is an intermediate downtrend. The Nifty found support a week ago at 9,685. It slid to 9,740 on Monday and if it breaks 9,685, it would confirm a pattern of lower lows. On the upside, there's resistance between 9,850 and 9,900. There's support below current levels at every 50 points.

To confirm the end of the correction, the Nifty must stay above 9,685 and ideally, bounce to beat the all-time high of 10,137. There's been a spike in the VIX and other bearish signals. The advancedecline ratio is negative. Volumes expanded during selling.

The proximate trigger was the battle within Infosys. But, there's also worry about banks, which have delivered poor results. A disappointing Credit Policy, poor macro-data and a gloomy Economic Survey (Vol 2) have also affected sentiment. Earning season has seen far more downgrades than upgrades.

Foreign Portfolio Investors (FPIs) have sold equity through August. Retail investors were also net sellers on Monday. Mutual funds and domestic institutions remain net buyers. The rupee has softened, to above ~64.10 /dollar despite FPI buying of rupee debt.

By definition, the longterm trend remains positive and the 200-Day Moving Average ( 200-DMA) is far below at about 9,000. The last positive intermediate trend (which may still be in force) bounced from support at 9,450 in late June to hit 10,137 in early August.

Taking a longer-term view, the Nifty moved North in late December 2016 from 7,900 levels to a high of 10,137 in early August. The length of time and the magnitude of this move also means that an intermediate correction could be severe. The first Fibonacci level is at around 9,250-9,300 and a dip below 9,000 would break the 200-DMA.

Simple trend following systems have closed out. The current trend-following signals suggest selling Nifty with a stop-loss at 9,900. Anybody who has open long positions would probably be placing stop-losses in the 9,625-9,650 zones.

The Nifty Bank has also reacted down from an all time high at 25,200 to 23,822 on August 10, before pulling above 24,000 again. On Monday (August 21) it slid to 23,882. The 23,800 support is critical and the financial index could swing till below 23,000 if that is broken. On the upside, resistance at 24,500 could be hit on a bounce. If that breaks, 25,000 is possible. The best part of two weeks is left. Three big trending sessions in either direction could hit either 23,000 or 25,000.

A strangle of long August 31, 25,000c (17), long August 31, 23,000p (43) is not zerodelta. Either side of this lopsided strangle could be hit. This can be offset with a short August 24, 25,000c (15), short August 24, 23,500p (43). This is not a calendar spread - all strikes differ. But, the long options will gain if short strikes are hit. The net position costs almost nothing.

Put-call ratios remain in bearish territory for September and for the threemonth period. The August Nifty call chain has peak open interest (OI) at 10,000c and high OI until 11,000c. The August put chain has very high OI between 9,500p and 9,800p, with high OI down till 9,000p.

The Nifty closed at 9,754 on Monday. A bullspread of long August 9,800c (65) short 9,900c (31) costs 34 and pays a maximum 66. This is 45 points from money. A bearspread of long August 9,700p (60), short August 9,600p (35) costs 25, pays a maximum of 75 and is 55 points from money.

These spreads are nearly zero-delta and could be combined. The resulting position costs 59, with breakevens roughly at 9,640, 9,860. One side is almost guaranteed to be hit.