Stocks might claw back as bears exit shorts

A short-covering rally happens when traders buy securities to close short positions. Photo: MInt
A short-covering rally happens when traders buy securities to close short positions. Photo: MInt


  • Rally may gather steam if FIIs cut bearish bets on index futures.

MUMBAI : Indian stocks, which rebounded in line with global markets after a brutal losing streak, could claw back more ground if foreign institutional investors (FIIs) cut their bearish bets on Nifty and Bank Nifty (index) futures when markets reopen after the Dussehra holiday.

The short-covering induced rally could see the benchmark Nifty index initially test a key level of 17,429, which, if broken decisively, could catapult it to 17,700-18,000, according to analysts who peg the support at the recent low of 16,748.

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A short-covering rally happens when traders buy securities to close a short position. For example, a short index futures contract on Nifty is covered by buying it back. Buying raises the price of a security. Along with covering (buying back) their futures positions on Tuesday, FIIs cut their holdings of index put options to 275,000 contracts from 313,000 the previous day. An index put gives the right to sell the index at a locked-in price on a future date.

The Nifty, which fell 1,209 points over 12 sessions through 3 October, jumped 2.29% to 17,274.30 the next day, amid a rally across markets. These indices rallied over 2% on Monday after weaker-than-expected manufacturing data in September raised investor hopes of the US Fed turning less hawkish. Also, a U-turn by the Bank of England to sell bonds caused the dollar to weaken against a basket of six currencies, enabling the rupee to strengthen to 81.52 from a low of 81.95 last week.

This drove FIIs to cut their cumulative index short positions in India to 81% on Tuesday from 87% a day earlier. To be sure, they remain significantly short, increasing the chances of an extension in the relief rally.

In absolute terms, FIIs cut their net bearish bets on index futures contracts by 35,677 contracts to 91,752 on Tuesday, the biggest drop since 20 May, when they covered 37,009 contracts.

The bearish positions were carried forward from last month, coinciding with increased choppiness due to rate hikes by global central banks, raising bond yields from the US to India, adding to the risk-off sentiment, until the heavily beaten Dow and Nasdaq recovered from their 52-week lows.

“What we are seeing here is short covering in line with the global market trend," said S.K. Joshi, executive director, Khambatta Securities. “Depending on global market cues, we could potentially rise to 17,700. If the rally fizzles out, we could test 16,700."

Manoj Murlidharan, vice-president (derivatives) at Religare Broking, said, “Around 75% of the rally in indices and stocks on Tuesday was led by short covering. Given that significant shorts still linger, a potential revival of risk-on sentiment globally could drive Nifty to 17,600-17,700 within a short span."

“Frankly, it’s tough to be reasonably certain as there are too many moving parts, which opens the room for data to turn on a dime, as we have just seen," said Rohit Srivastava, founder, IndiaCharts. “However, if we break 17,429 without falling, the odds of our testing 18,000 shorten. If we falter, though, supports of 17,100 followed by 16,750 could be revisited."

FIIs have net sold $7.7 billion in Indian stocks in FY23 so far, after selling $18.46 billion in the previous fiscal.

Along with this, they remain cumulatively short index futures, which act as hedges to their cash holdings of nearly $600 billion.

By selling a futures contract, an investor hedges his cash position against a possible correction. If the cash shares fall, the short index position or a put option offsets the loss by rising in value.

The hedger transfers the risk to a speculator who takes an opposite view.

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