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What F&O trends indicate about Nifty crossing 10,000

LiveMint logoLiveMint 26-07-2017 Shakti Patra

On a day the Nifty 50 index crossed 10,000 points, the key question among investors was whether the markets had run ahead of fundamentals. It’s not just price-earnings multiples which are at multi-year highs, but also positions in the derivatives market that show a high order of exuberance in Indian equity markets.

Take, for instance, the open interest positions in the stock futures markets. Since equity derivatives were introduced at the beginning of the last decade, stock futures have been the preferred instrument for traders to maximize returns since they allow one to take a position just by paying a small margin. They are often the best proxy to measure leverage in the market as well.

The open interest, which refers to the outstanding position in a contract, in stock futures at Tuesday’s close was 4.77 billion shares. In comparison, when the Nifty hit a previous high of 9,119 on 4 March 2015, the number was 2.7 billion shares. Even at the height of exuberance in the previous bull run, when the Nifty was trading at nearly 20 times towards the end of 2007 and early 2008, open interest was lower. On 8 January 2008, when the Nifty hit a high of 6,357, open interest was 2.37 billion shares.

The doubling of open interest positions at a time when prices have gained 60% since 2008 means that the markets are around 220% more leveraged now compared to the pre-global financial crisis highs.

“Although sentiment indicators reflect excessive bullishness, which historically have led to 5-10% corrections, the impact has been muted this time around due to huge liquidity from domestic funds. But I don’t expect the party to carry on too much longer,” said Rohit Srivastava, a fund manager at brokerage Sharekhan-BNP Paribas .

One saving grace is that these stock future positions are better hedged than earlier. In India, while stock futures are mostly used for leverage, index options are largely used for hedging, since they help in limiting the downside when a bet goes wrong.

Outstanding Nifty option open interest—often considered a proxy for the amount of hedges in the market—indicates that the markets today are better hedged than in 2008.

Consider this: the total outstanding open interest across Nifty options was 26 million shares on 8 January 2008. On Tuesday, the comparable number was 170 million shares. The outstanding open interest in just the nearest three month contracts—the only options available in 2008—is also a healthy 126 million shares.

“While the leverage is significantly higher today than in 2008, the main difference is brokers today have adequate margins from their clients which was not the case then,” said Rajesh Baheti, MD, Crossseas Capital Services Pvt Ltd.

“Several brokers had then funded clients and allowed them to take up massive positions in stock futures with hardly any margin backing them. So, essentially, all the risk was on the books of brokers which forced them to liquidate positions left, right and centre when the crash began, which only further aggravated the situation. Today, the stock futures segment is structurally on much more solid grounds,” he said.

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