Weekly Market Outlook 8th-12th June 2009

Strong & Weak  futures  for 8th June
This is list of 10 strong futures:

JP Hydro, Aban, Bajaj Hind, MRPL, S Kumar Syn, Rajesh Expo, Welguj, Omaxe, Sobha & IVRCL Infra.

And this is list of 10  Weak :

ITC,Sterlin Bio, Cipla, Sesa Goa, Dabur, Bharti Airtel, Relinace, Glaxo, Sunpharma, Lupin & GTL.
 Nifty is in Up Trend .

Floundering at 15000

Sensex (15103.1)

After the fantastic journey from 8000 to 15000 in three months, Sensex appeared a little lost last week. News flow drying to a trickle and ambling ways of other equity markets could have contributed to this indecisive state. Further, conflicting statements emanating from the Government on disinvestment and on the thrust of the Union Budget made market participants nervous. The Sensex finally slipped past the 15000 mark on Friday afternoon to end with a 3.2 per cent weekly gain.

Second, third and bottom-rung stocks continued to attract immense investor interest and market breadth was positive, even on days when the Sensex closed with losses. Volumes, especially in the cash segment, were very strong, daily turnover last week was almost 50 per cent above the average daily turnover recorded in April. However, inflow of overseas funds was tepid last week

The sideways move recorded by the Sensex over the last two weeks has made the momentum drop significantly. The 10-day Rate of Change (ROC) oscillator fell sharply last week from overbought levels. But the fact that the 10-month ROC has moved in to the positive territory is an encouraging signal. If this indicator sustains above the zero line, it would signal a change in the long-term outlook for Sensex.

There is no sign of reversal in the medium-term up-trend from the March lows yet. We have repeatedly warned against fighting this trend and initiating pre-emptive short positions over the last two months. The market is known for its vagaries that can outwit the best brains. Docile trend-following can be the best way to play such a strong trending market.

Targets of the third leg of the up-move from 8047 are 14281 and 16332. Since 61.8 per cent retracement of the down-move from January 2008 peak occurs at 16180, next medium target on a strong close beyond 15300 can be between 16000 and 16300. But it needs to be borne in mind that 15284 (55 per cent retracement) is also a likely peak for the move from March low.

As far as the short-term is concerned, we had outlined two trajectories in our last column. Despite a brief move past 15200, Sensex ended the session below this level. If the decline continues next week, the index can decline to 14594 or 14185. Short-term purchases should be avoided on a close below the first target. The medium-term view will, however, be roiled only on a close below 13470. Resistances for the week ahead would be at 15284, 15698 and 15836.

Nifty (4586.9)

However, minor counts of the move from 2555 indicate that the fifth of C-wave is currently in motion that can terminate at 4428, 4597 or 4791. The second target was achieved last week and traders should tread cautiously as far as long positions are concerned unless there is a clear break above 4650 early next week. We are looking at the possible termination of the move from March lows here.

Supports for the week would be at 4428 and 4300. Fresh long positions ought to be avoided below the first support. Medium-term investors however need not worry until the index closes below 4150. Resistances for the week would be at 4646 and 4758.

Global Cues

It was a relatively sedate week in global equity markets. Most indices closed with 1 to 3 per cent gains. Some Asian indices such as those belonging to Thailand and the Philippines out-performed with over 5 per cent gains. CBOE volatility index traded around the 30 mark and closed with a small up-tick indicating that while investor confidence remains high, it has not received a fresh boost over the past week. The base built by this index during the bull-market days between 2004 and 2006 is between 10 and 20.

The Dow moved higher to an intra week peak of 8839 last week and closed slightly above its 200-day moving average. But the index needs to sustain above this line for a couple of weeks more to signal a long-term trend reversal. Medium-term target of this leg of the up-move in Dow is 8796 and 9410.

If we apply the waterfall effect in Elliott wave analysis, the Dow could reverse anytime soon from the resistance zone around 8800. Heavy negative divergence in both daily and weekly momentum too signal the uptrend from March trough could be drawing to a close. These divergences are apparent in the S&P 500 too and further this index has also reached its key medium-term target of 943 that was the peak formed on January 9.

 

WEEKLY LEVELS ON STOCKS BASED ON PIVOTS

Tata Steel (Rs 463.9)
 

Tata Steel led the market forward last week with a 14 per cent gain. The stock moved slightly above our second medium-term target of Rs 487 to peak at Rs 496. There could be a short-term correction to Rs 448 or Rs 416 in the near term. Short-term traders can buy on such declines with a stop at Rs 410. Resistances for the week would be at Rs 481 or Rs 496.

The stock is in a strong medium term up-trend and this move can continue to take Tata Steel towards the medium-term target of Rs 552. The positive medium-term view will be marred only on a close below Rs 330.

Reliance (Rs 2211.8)

RIL moved in line with our expectation, reversing below the resistance indicated last week thus highlighting the weak outlook for the short-term. The stock can decline to Rs 2094 or Rs 2066 in the near-term and a close above Rs 2343 is needed to reverse this view. The ceiling of the gap formed on May 18 at Rs 2102 will be the key short-term support for the stock.

We continue to advise caution from a medium-term perspective unless there is a weekly close above Rs 2384. A gradual decline to Rs 1900 or Rs 1700 can not be ruled out in the medium term.

Maruti Suzuki (Rs 1082.7)

Maruti recorded yet another spurt last week that made it rally above our medium-term target of Rs 1100 to peak at Rs 1113. The stock is halting at the upper boundary of the trend-channel that is enclosing the stock's movement since January 2009. Reversal from here can drag the stock lower to Rs 960. But the medium-term view will stay positive as long as this level holds. If it holds above Rs 960, Maruti can have another shy at its all-time high over the medium term.

State Bank of India (Rs 1817.9)

SBI reversed lower from an intra week peak at Rs 1935 to close with 2.7 per cent weekly loss. The stock is currently pausing at the key intermediate-term resistance at Rs 1827. A reversal from here can drag the stock lower to Rs 1537 or Rs 1300 over the medium term. Fresh purchases are therefore recommended only on a strong close above Rs 1827. Subsequent target is Rs 1970.

The stock can decline to Rs 1770 or Rs 1670 in the short-term. Near-term trend will however turn overtly negative only on a close below Rs 1750. Resistances for the week are Rs 1920 and Rs 1935.

Infosys (Rs 1690.5)

Infosys moved in line with our expectation and rallied to the intra-week peak of Rs 1706. But the stock is pausing below this resistance. The near-term view will be ambivalent as long as the stock remains at these levels for a move above Rs 1706 can take it higher to Rs 1830 while failure to surpass this level will cause a decline to Rs 1500 again.

Our medium-term view for Infosys stays negative as long as it trades below Rs 1750. Failure to move above this level over the next two weeks can cause a decline to Rs 1486 or Rs 1400 over the medium term.

ONGC (Rs 1180.6)

ONGC is currently in a short-term correction that is making the stock move in the range between Rs 1140 and Rs 1220. Short-term investors can buy on declines with a stop at Rs 1085. The stock can move higher to Rs 1257 or Rs 1340 in the near term.

SPOT LEVELS for 8th June

	4586.90	( 0.31 %)	14.25
		1	2	3
Resistance		4628.52	4670.13	4703.42
Support		4553.62	4520.33	4478.72

	15103.55		( 0.63 %)	94.87
			1	2	3
Resistance			15242.70	15381.85	15506.40
Support			14979.00	14854.45	14715.30

FUNDS DATA 5th June

FII trading activity on NSE and BSE in Capital Market Segment(In Rs. Crores)
Category	Date	Buy Value	Sell Value	Net Value
FII	05-Jun-2009	4022.61	3190.66	+831.95

DII trading activity on NSE and BSE in Capital Market Segment(In Rs. Crores)
Category	Date	Buy Value	Sell Value	Net Value
DII	05-Jun-2009	1436.44	1916.57	-480.13

 

Interpreting RSI

Since most of us now generate RSI with our computer software, the rigour of manually calculating the RSI can be dispensed with. It would suffice to understand that RSI judges the strength in the prevailing trend by tracking the gains or losses made over a pre-defined period.

The RSI oscillates between the values of 0 and 100. The zone between 0 and 30 is considered as the 'oversold' zone. When RSI declines to this zone, it means that the selling might have been overdone and an upward reversal could be around the corner.

Spotting divergence

 

Similarly, the zone above 70 and below 100 is considered as 'overbought'. RSI reaching this zone implies that the stock may be getting overvalued and a pullback or correction is likely soon. The RSI tends to peak or bottom before the underlying price chart thus giving advance indication of an impending trend reversal.

When the stock price is moving up forming higher peaks but the RSI oscillator is moving lower forming lower peaks, a negative divergence occurs. Likewise, when the stock price is trending sideways or lower, shaping lower troughs while the RSI oscillator is forming higher troughs, a positive divergence is formed.

Positive or bullish divergence is seen in the Bharat Forge chart. The stock made lower troughs during October-December 2008, while the RSI was forming higher troughs in the same period. The RSI bottomed first in October 2008 while the stock price was trending south.

 

In Dr. Reddy's Lab's stock, one can notice that during December 2008, the the relative strength index formed higher peak in line with the price action only up to Rs 720. After the Rs 720 peak, the RSI headed southward while the stock price was still moving higher creating divergence between the two. This negative divergence acted as a trigger for the stock's subsequent trend reversal.

Backspreads: Attractive for discerning traders

Backspreads reduce risks if the underlying trades in a range.

Traders are increasingly using options to take a view on the underlying security or market. The problem, however, is that options expire worthless if the underlying does not move enough within the contract expiry.

Several traders, hence, wanted to know if they could set up positions that pay off no matter whether the underlying goes up or down.

This article discusses one such trade set up – backspreads. It shows how to construct the position and why the set up generates positive payoffs so long as the underlying moves in either direction.

It also explains the risks associated with the position.

Initiating trade set up

Suppose a trader holds a view that Reliance Industries will move to Rs 2,700 if it breaks above Rs 2,400. The alternative view is that the stock could decline to Rs 2,100. This view could be typical for a straddle/strangle set up. The objective, however, is to reduce risk if the underlying trades in a range.

Besides, the trader has an upside bias (or downside bias), unlike in a straddle/strangle where the view is neutral. She can, hence, set up a call/put backspread. We assume that the trader shorts one contract of June 2250 calls and buys two contracts of June 2460 calls.

Understanding the set up

Call backspread is a two-leg transaction where the trader shorts a lower strike call and buys higher strike call. Two features make this position somewhat unique. One, the position is set up as a delta-neutral spread.

That is, the delta of the short options equals the delta of the long options. And two, because of delta-neutrality, the trader purchases more contracts of higher strike calls than she shorts the lower strike calls.

Delta is the change in the option value for a one-point change in the underlying.

If a call option has 0.50 delta (also referred to as 50 deltas), it means that the option value will increase (decrease) by 0.50 for a one-point increase (decrease) in the underlying.

The backspread is set up delta-neutral to minimize the risk for small movements in the underlying.

The trader can set up the spread for a net credit. This is because she shorts an ATM (at-the-money) option and buys OTM (out-of-the-money) option.

The June 2250/2450 backspread can be set up for a net credit of 30 points based on Thursday prices, not including brokerage commissions.

If the stock moves to Rs 2,700 by, say, June 23, the 2250 strike will be worth 450 points (rounded off) with minimal time-value. The June 2460 strike will then be worth 240 points for a total of 480 points.

The trader, hence, receives 30 points on closing the position. This coupled with another 30 points on initiation gives the trader a total gain of 60 points.

Payoffs

But what if the stock instead moves to, say, Rs 2,100? Both the June 2250 and June 2460 calls will expire worthless and the trader nets 30 points- the premium collected on initiating the position.

Suppose the stock trades at Rs 2,350 at expiry.

The June 2250 will carry an intrinsic value of 100 points (2350 minus 2250) whereas the June 2460 will expire worthless.

The net loss will then be 100 points less 30 points collected on initiation.

Conclusion

Backspread differs from straddle/strangle in that it is delta-neutral and is typically set up as a net-credit spread. The flip side is that the position is subject to high risk when the stock trades between the break-even point and the long-strike option.

In the above example, the position will suffer large losses if the stock trades above Rs 2,280 (Rs 2,250 plus 30 points premium) but below Rs 2,460 at expiry. Besides, the position is sensitive to change in volatility (vega).

It would be optimal to set up backspreads when the implied volatility is low. The trade set up is suitable for discerning option traders considering the associated risks.

 

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Arvind Parekh
+ 91 98432 32381