After last week's steep plunge, a key market indicator is flashing green

The Nifty may be poised for a rebound after falling nearly 5% over the last four sessions, with a key indicator showing the selling frenzy has taken the index to oversold territory.

The put-call ratio (PCR), which shows how many Nifty put options relative to call options (monthly as well as weekly series) are outstanding or open, has broken a one-year low of 0.7 to hit 0.69 on Friday, as per data analytics firm IndiaCharts. The low PCR, while underscoring the bearish sentiment as foreign funds favour China and conflict clouds West Asia, signals that a bounce could be around the corner.

"Whenever the top or the bottom of the range is tested, the markets reverse, at least in the short term," said Rohit Srivastava, founder, IndiaCharts.

Ratio signals

A 0.69 ratio means that for every 100 calls sold, only 69 puts have been sold. Normally, the ratio ranges between 0.7 and 1.3. These levels can be broken, but the market tends to trade within the range. A low ratio signals traders are bearish, while a high ratio implies they are bullish. However, when these touch extreme levels, markets typically make a short-term reversal.

For instance, as early as 20 September, the PCR was 1.5 (150 puts sold for 100 calls sold) and the Nifty was at 25790. From there, Nifty has fallen 3% to Friday's 25014.6 and the PCR to 0.69. On 4 June, the day of the Lok Sabha election results, the PCR was 0.73 and the Nifty closed at 21884.5. From there, it rose 8.4% to 23721 on 25 June, along with the PCR which jumped to 1.38.

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The Nifty has fallen 4.8% from a record high of 26277.35 on 27 September to 25014.60 on 4 October. This puts it tantalizingly close to a pullback, which implies a 5-10% fall from the high.

The fall was driven by FII selling, with short-term investors booking profits here for deployment in Chinese stocks, after the world's second-largest economy announced a $1.07 trillion stimulus package late last month to counter a slowdown.

Crude oil spike

Meanwhile, the conflict in West Asia has fuelled a spike in crude oil, which rose almost 9% to $78.08 a barrel last week, on fears of an Israeli reprisal on Tehran's oil and gas assets. A sharp and prolonged rise in crude could impact India's current account deficit and rupee, a negative for FII returns.

To put it in context, the Shanghai Composite Index surged a whopping 15.2% in just four days from 24 September through 3336.50 on 30 September after China announced the stimulus. That market is due to open on Tuesday after the Chinese national holiday.

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Over the comparative period, Nifty fell 0.5% through 25811. The fall was more precipitous in October, with FIIs dumping shares worth ₹27142 crore over just three days, shows NSDL data. This, after four straight months of buying shares worth ₹1.24 trillion.

Market veteran Sanjeev Prasad, MD & co-head of Kotak Institutional Equities, said hot money flows would shift to China from India, where valuations remain elevated.

Closing shorts

While the markets have seen a sudden fall over the past four days, retail/HNI clients have closed out their shorts and turned long, which is giving market-watchers like Srivastava added "hopes of a bounce being in the offing."

Retail/HNI clients who were net short Nifty and Bank Nifty by as much as 255,142 contracts on 23 September closed these out through 4 October when they turned net long by 31,319 contracts.

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"A recovery is possible after the recent sharp fall, but whether it persists is anybody's guess, given the ambient global cues," said Chandan Taparia, senior vice-president and research head - derivatives and technical, Motilal Oswal Financial Services. The recovery could be led by "bargain hunting, support level buying and festive sentiment," he said.