The Hindu Business Line : No cause for worry in F&O segment

Chennai June 26 The last Thursday of every month induces that period of sleepless nights for players in the derivative segment when they have to decide whether their positions should be rolled-over, squared-up or allowed to expire. The expiry day of June 2007 will be of great interest to all market watchers because the open interest is currently at a record high, nudging Rs 80,000 crore.

History suggests that an escalating open interest is usually a cause for worry. The May 2006 crash in the Indian markets was exacerbated due to the massive build-up of leveraged positions in the derivative segment. The compulsory unwinding of stock futures held by retail segment in that period doubled the magnitude of the fall in this period.

Dip in stock futures

But a dissection of the current open interest reveals that the fears regarding over-heating in the derivative segment is unfounded. The most important factor that leads us to believe that the markets are stronger this time around is the decreasing portion of the open interest of single stock futures. On May 12 2006, just before the plunge, the open interest in this segment was Rs 34,000 crore. It has inched up slightly to about Rs 37,000 crore in June 2007. However, proportion of stock futures in the total open interest has actually dipped from 63 per cent in May 2006 to 47 per cent currently.

Fall in the open interest in single stock futures is a cause for celebration because the retail investors with less holding power are more active in this segment. The stagnant open interest in stock futures despite the doubling of the overall open interest indicates that the retail investors might not be the driving force in the derivative segment today.

Active index options

The ground yielded by the stock futures has been captured by index options. Proportion of index options in the total open interest has almost doubled from the levels recorded in May 2006. Since index options are primarily used as a hedging tool, the increase in the open interest could be largely attributed to hedging by large funds and institutional investors.

Stagnant turnover

The turnover in the derivative segment too has not reached frenzied levels yet. The daily average turnover on the derivative segment of the NSE in June 2007 is about Rs 35,000 crore. This is still below the record of Rs 41,000 crore made in April 2006. The bloating open interest despite a stagnant turnover can be explained by the fact that the market has been moving sideways over the last two months. Both the bulls and the bears would feel that they stand a chance in such a market and hence could be willing to hold on to their positions.

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