Indian stocks plunged 630 points on Tuesday following renewed concerns about Greece’s future in the euro zone. But why is the Sensex behaving like a yo-yo, up 2% one day and down 2% the next? Indian markets are the most volatile among emerging and developed markets.

For instance, the Sensex gained 479 points on Monday last week, only to plunge 723 points on Wednesday, which was followed by a 506 point rally on Friday. This week too, the markets started off on a firm footing, rising 402 points on Monday, followed by a sharp slide on Tuesday.

The market gyrations in India are relatively steep compared with other emerging market indices like China’s Shanghai Composite and Indonesia’s Jakarta Composite index. India’s VIX, or volatility index, has also gone up around 20% in the past week.

One reason for the sharp swings for Indian markets could be a short-covering rally amid a broader downtrend on low cash volume. Short covering is the purchase of futures that were initially sold when investors were of the view that the stocks are going to fall further. The total cash market turnover has been going downhill since March, when the markets peaked. Trading on thin volumes heighten market movements and increase volatility.

“The market had been moving up on thin volumes in the cash segment, suggesting it was short covering in the derivatives segment, which was propelling the rally," said Gaurav Mehta, vice-president of institutional equities at Ambit Capital Pvt. Ltd. Foreign institutional investors (FIIs) have sold shares worth 14,826 crore in the cash segment in the last 16 sessions of trade, barring 21 April when Daichi Sankyo sold its stake in Sun Pharmaceutical Industries Ltd, according to data from the Securities and Exchange Board of India.

Indian equities have plunged the most among emerging markets since March because there was over-ownership by foreign investors. Money has been moving to commodities and other equity markets like China that have started performing. “Foreign investors have been unwinding or selling long index future positions," said Siddharth Bhamre, head of equity derivatives and technical at Angel Broking Pvt. Ltd.

FIIs are buying into index put options heavily. A put option gives an investor the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time. “Expect more volatility on the cards since foreign investors are moving into index options from index futures. FIIs are buying a put option which is speculative, as they are betting that the market is going to fall further," said Bhamre.

The writer doesn’t own shares in the above-mentioned companies.

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