Karnataka results to dictate trend
The Nifty looks set to go North, but it could see a trend reversal if the Karnataka Assembly results are not to the market’s taste. In fact, that event will determine the short-term trend. This is one of those rare situations of “known unknowns” where the market has no reliable information to bet on.
Normally, any analysis of market trends starts with an assumption that the movements represent consensus opinion based on aggregated, discounted information. However, the outcome of free elections is an unknown.
If the Bharatiya Janata Party (BJP) wins a majority, the market will respond positively. If the Indian National Congress (INC) wins a majority, there will be a sell-off. If there's a hung assembly, there will be a waiting phase until some party cobbles up a working majority. I am basing this prediction on the basis of movements since 2014, when every BJP electoral victory has triggered buying while reverses have led to sell offs.
The Nifty has inched above 10,800, and purely on the basis of previous trading patterns, we'd predict a movement till 10,950 or so. In practice, since election results can’t be discounted, the shortterm movement could be 3-4 per cent either way.
One way to understand the situation is to look at option premiums close to money. The straddle at 10,800c (126), 10,800p (122) is priced reasonably with the index held at 10,807. The 10,600p (61) and 11,000c (38) are both 200 points from money. But, the put premium is much higher. The open interest (OI) in the 11,000c is 6.7 million while the 10,600p has OI of 4.8 million.
The market is likely to open high/low depending on early counting trends. But for arguments’ sake, suppose a trader hedges by buying the long 10,800c, long 10,800p. He pays about 250 and breakevens are at 11,050, 10,550. Instead, he could buy long 10,600p, long 11,000c. He pays about 100 for this strangle, and gets breakevens at 11,100, 10,500. Alternatively, he could buy the 10,800c, 10,800p, and sell the 10,600p, 11,000c. That costs a net 150 and pays a maximum 50.
None of these positions look attractive. But they give a sense of consensus estimates. Traders expect a swing of about 2.5-3 per cent. Fewer traders expect corrections but if corrections occur, they may go deeper than the uptrends, going by premium asymmetry. Breadth is negative at the moment. The VIX has risen somewhat, which is a bearish indicator. The put-call ratio is bullish with open interest in puts exceeding OI in calls.
The index would have to cross 11,170 in order to confirm the big bull market is still alive. On the downside, there's support at 10,600, and at roughly 50-point intervals below that. The 200-day moving average (200-DMA) is around 10,300. A fall below 10,250 would push the index below its own 200-DMA and if that happens, it indicates that this entire upmove was a “dead-cat bounce”.
Regardless of the short-term sentiment, the rupee is under pressure. It could snap back if crude prices ease up. It could also snap back if the FPIs stop selling massive rupee debt. However, trend-following signals suggest staying long on dollar. The latest inflation data makes it a near-certainty the Reserve Bank of India won't cut rates. Indeed, the central bank might just hike in June.
The Nifty Bank has edged up to 26,400 and it could swing 3-4 per cent, along with the election results. The advance-declines situation is negative in the sector but that doesn't matter when dealing with few stocks in these specific circumstances.
A strangle with long May 31, 25,800 (63), long May 31, 27,000c (39) could be hit in two or three trending sessions. It is zero-delta and costs about 105. Again, note the a symmetric premiums - the put is priced much higher.