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Lokeshwarri S.K.

BL Research Bureau The unprecedented slide in equity markets has impacted the sentiment among investors as well as traders.

The cautious mood among traders is reflected in the plunging open interest in the derivative segment of the National Stock Exchange (NSE).

Open interest is the value of the outstanding contracts in futures and options that have not been squared-off at the end of a day. While a high open interest reflects confidence among traders in anticipating and exploiting future moves of stocks and indices, low open interest implies that the stock market has become unpredictable.

Total outstanding contracts in the derivative segment of NSE were hovering around Rs 56,000 crore on November 25. This figure typically peaks on the expiry day, which is the last Thursday of every month. The outstanding contracts in November have shrunk to 60 per cent of the open interest on the expiry day in January. Open interest close to expiry has ruled above Rs 75,000 crore in 2008, with the exception of March.

The main reason behind this reduction appears to the reluctance on part of traders to carry forward their positions from one day to another. Our markets have been largely following cues from overseas over the last two months. This has resulted in the stock markets opening in the morning with a large downward or upward gap almost every other day. This would have led to traders recording losses on positions brought forward from the previous trading session.

The strategy being adopted currently is to initiate a trade in the morning and to square it off by the end of the trading session. The large swings made by the stock markets during the trading day are largely caused by these intra-day trades.

Average trading volumes are also down 20 per cent in November, implying that many could have withdrawn from active trading. Retail investors appear to be the worst affected by the meltdown in prices. The share of retail investors in the turnover in derivative segment has declined from 67 per cent in November 2007 to 55 per cent in October 2008. Proprietary trading (brokers trading for their own gain) has seen its share increasing from 24 per cent to 33 per cent in the same period. Interestingly, the share of institutional investors has not undergone any great change; fluctuating between 10 to 15 per cent.

Another factor that points towards reduced retail participation in the derivatives segment is the increased share of index options (mainly Nifty options) in the open interest. Index futures and options make up 70 per cent of the open interest now relegating stock futures, which were the retail investors’ favourite instrument, to a distant second.

More Stories on : Derivatives Markets | Stock Markets

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