Markets
A retreat of bears lifted stocks. Is that enough?
Summary
- On Tuesday, the value of bearish bets over bullish ones had hit a record, following unpleasant data from the US and an unexpected rate hike in Japan. This indicates Wednesday's rally was led by bears covering their short bets.
After three gut-wrenching days for investors, stocks rebounded and a sense of calm returned, even as worries remain if the Wednesday's rally led by short-covering will tempt foreign investors back to the market.
A day earlier, the value of bearish bets over bullish ones had hit a record, following unpleasant data from the US and an unexpected rate hike in Japan. This indicates Wednesday's rally, sparked by Tokyo's assurance that it won't raise interest rates when markets are unstable, was led by bears covering their short bets.
On Tuesday, the value of market-wide call option open interest (OI)—open buy-sell positions—exceeded that of put options by ₹5.9 trillion, a record high. The previous such record was ₹5.49 trillion on 4 June, when the Bharatiya Janata Party's failure to win a simple majority in the Lok Sabha elections spooked investors.
Bond yields plunged and stocks rose across markets after Wednesday's soothing words from the Bank of Japan, with the Nifty gaining 1.27% to close above the 24,000 mark at 24297.5, while the Sensex rallied 1.11% to 79,468.01. Fear gauge India Vix closed 13.72% lower at 16.17. However, BoJ's intent on higher rates, worries over the US economy and war clouds over the Middle East continue to trouble investors.
Near-term calm
The calm has been restored for the very near term, market experts said, warning that any blow-up in the Middle East could undermine a sustained recovery.
“Record high negative options bets created on Tuesday meant that a sliver of good news would result in a bout of short-covering," said Rohit Srivastava, founder, IndiaCharts. “This is what exactly happened with BoJ’s dovish comments on rate hikes on Wednesday."
On Wednesday, foreign institutional investors (FIIs) sold a provisional ₹3,314.76 crore of shares, while domestic institutions net purchased ₹3,801.21crore.
On 31 July, BoJ had raised its short-term policy rate to 0.25%, only the second hike in 17 years, sending the Nikkei crashing 12.4% on Monday. Fears of an unwinding yen carry trade whipped stocks worldwide, worsened by worries of a hard landing in the US.
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The Nifty tanked 4% from a closing record high of 25010.9 on 1 August to 23992.6 on Tuesday. This culminated in option sellers writing or selling more calls than puts on Tuesday, a bearish sign. However, the BoJ’s dovish comments have caused some of these bearish bets to be covered, added Srivastava.
Sellers write more calls than puts assuming markets won’t rise above a certain level, and that they would get to pocket the premium paid by the call buyers. But, if their premise goes wrong, they rush to cover the shorts which involves buying back what they sold earlier. This powers a rally, subsequently leading to fresh buying.
“The BoJ comments spurred the short-covering and calmed markets," said Andrew Holland, CEO, Avendus Capital Public Markets Alternate Strategies.
Hard to predict
Holland said that simmering tensions in the Middle East made it hard to predict any duration for the continuation of the recovery, but that markets could rally more for a couple of sessions.
The short-covering was visible in the weekly 24,000 and 24,200 call strikes expiring on Thursday. The 24,000 call witnessed OI falling by 94,321 contracts to 67,953 contracts, which drove up its price 125% to ₹349.4 a share (25 shares make one contract). The 24,200 call expiring on Thursday witnessed OI plunging by 90,657 contracts to 98,779 contracts which catapulted its price 167% to ₹175 a share.
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The call selling was led by proprietary traders whose cumulative net short on index calls (Nifty and Bank Nifty) stood at 772,854 contracts on Tuesday. Retail/HNI, FIIs and DIIs were net long index calls.
Nilesh Shah, managing director of Kotak Mahindra AMC, has advised clients to not “overtrade" and to take risks only which they can afford.
Meanwhile, mid- and small-caps outperformed large-caps, with the Nifty Smallcap 250 index gaining 2.39% at 17274.9 while the Nifty Midcap 150 rallied 2.2% to 21063.7.
