There has been a steady rise in the turnover of Nifty products in the past few months. In the first two weeks of this month, average daily index futures and options turnover stood at Rs23,300 crore on the NSE’s derivatives segment, 11% higher compared with the first two weeks in January. For perspective, turnover of the exchange’s entire derivatives segment has dropped by 42% to a daily average of Rs40,000 crore over the same period. As a result, the share of index products has nearly doubled to 60%. And this is not because of new products such as the mini-Nifty series and long-term options. These new introductions account for less than 3% of total turnover on index products.
The rise in the preference for index products is a direct fallout of the uncertainty in the markets. Hedging activity generally picks up while stocks are correcting sharply—the share of index products had even risen during the May-June 2006 crash and the correction during February-March 2007. But that’s not to say the majority of all index derivatives trades are related to hedging during a bearish phase. A fair bit of trading interest shifts to index products when prices are correcting, simply because the Nifty is far less less volatile than most stocks on which derivatives trading is available. What’s more, a whole load of brokers have barred clients from taking fresh positions in the stock futures segment. After the torrid experience in January when some of these brokers had to forcefully square off open stock futures positions and bear losses on behalf of errant clients, almost everyone is being twice shy. It’s not surprising that open interest in the stock futures segment has fallen to a third of the levels just before the correction began in January.
Many option traders, too, have come to the fore in the recent past. Average daily turnover on index options so far this month have risen by 42% compared with the first two weeks of trading in January. The majority of the rise in on account of call options. Just prior to the correction in January, about 1.6 Nifty put options traded for every call option contract. The situation has now nearly reversed, with 1.3 call options being traded for every put option contract. With the markets declining almost every week, call option writers are assured they can pocket the option premium, which is why there’s a sudden rise in this tribe. But there are also some dedicated option trading desks which brokers have set up to gain from arbitrage opportunities and execute relatively low-risk strategies such as delta hedging, where a trader hedges an option position using the futures market and earns a small spread.
The preference for index products usually picks up when the markets correct. Going by that premise, and considering that risky assets may be out of favour for some time now, index products can be expected to rule the roost as far as the equity derivatives market is concerned.
While retail investors and proprietary desks have fled the equity derivatives scene due to huge losses and/or margin calls, foreign institutional investors (FIIs) have quietly increased their exposure. But wait a minute. Aren’t FIIs using the participatory notes route supposed to wind up their derivatives trades in about a year’s time? Yes, but NSE numbers show that FIIs account for 44.3% of the total gross market position on its derivatives segment, up from 40.4% just prior to the participatory note ban on derivatives trades.
One can be excused for thinking that the FII share has risen simply because domestic players have wound up positions, but note that their open interest has also risen in contract terms since the participatory note restrictions became effective on 26 October. In fact, if the derivatives market hadn’t shrunk in the past few months, outstanding positions would have been much higher. At its peak in January, FII open interest was as high as Rs95,000 crore, 67% higher since the participatory note restrictions were effected.
What gives? It seems most FII trades in this space are done by those directly registered with the regulator; those who weren’t seem to have to quickly got their registration going. Interestingly, FIIs have cut their single stock futures position by 61% since January, in line with the shrinkage in the entire segment. Most positions are related to arbitrage with the cash market, and with the retail segment cutting exposure to a third, the arbitrage activity just got stifled.
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