The derivatives market could provide new clues as to why Indian markets have been more resilient than other emerging markets in the current correction in global equities.
Indian benchmark indices have only fallen about 11% since their peak in late July, compared with an average fall of 18-20% in other emerging markets. Open interest, or outstanding positions on futures contracts, have remained steady at about Rs60,000 crore despite the market’s fall, indicating that the market is holding on to leveraged positions. If the fall in global equities were to continue and foreign institutional investors (FIIs) remain net sellers as they have in the past few trading sessions, these positions could be forced to get unwound.
Open interest stood at Rs61,000 crore on 8 August, when the Nifty was at 4,462 points. The index fell about 8% between then and 16 August, but open interest declined just 3.3% to Rs59,000 crore in that time. On 16 August, when the markets fell by over 4%, open interest fell by just 0.4%.
Sunil Jain from the alternative research desk of Edelweiss Securities Ltd points out that the drop in open interest in value terms was because of the fall in share prices. In terms of contracts, outstanding positions increased on 16 August.
Ajit Surana, managing director at Dimensional Securities, says the fact that the futures open interest position hasn’t declined is a cause for worry. Some analysts say overall open interest hasn’t fallen because fresh short positions are being built up. But, as Surana points out, for every fresh short position there is an equal and opposite long position. Some sections of the market may have gone short, but others have more than made up with long positions.
FIIs, for instance, were net sellers worth Rs4,850 crore in the four trading sessions until 16 August. These could either be square-off trades against previous purchases or fresh short positions. C.K. Narayan, head of the equity derivatives desk at ICICI Securities Ltd, says most short positions being built by FIIs in recent days are fresh shorts being taken for hedging purposes. “Most FIIs are still sitting on decent profits on their Indian positions and with the growth story remaining intact, they want to hedge their portfolios.”
To be sure, open interest on Nifty futures rose by 10% in terms of number of contracts on 16 August, and another 15% on 17 August, days when market volatility was at its peak.
But apart from FIIs, it’s more relevant to see what the market as a whole is doing. And that sign is worrying, as leveraged positions in futures are being held on to. In May and June 2006, when the markets had corrected sharply, market-wide open interest positions had declined considerably. While the large extent of unwinding had led to a sharper drop then (about 30% from its peak), it had also helped in the market’s recovery because of the lower baggage of leveraged positions.