A massive short-covering in equity stock futures has been a key reason for benchmark indices Nifty and Sensex hitting record highs in July. Both the indices registered nearly 6 per cent gains in July since the expiry of June series derivative contracts.

Short-selling refers to the selling of stocks without delivery in the futures segment, anticipating a profit from a price fall. But a SEBI-enforced deadline to unwind sparked a covering of positions, forcing short-sellers to rush to buy back at any price, pushing up the market.

Data show that the Nifty and the Sensex gained 6 per cent since June 29, the last derivative expiry, mainly due to massive short-covering in derivative contracts, a large chunk of which could be held in the form of P-notes.

The domino effect of this P-note-related short-covering by FPIs (foreign portfolio investors) led even other categories of investors to cover their short positions, pushing up the indices to record levels.

SEBI recently banned any fresh issuances of P-notes on derivatives and ordered an unwinding of the existing contracts. “The short-covering in single stock futures and July’s market rally could be attributed to the ban on P-notes,” said Rishi Kohli, CEO, ProAlpha Capital.

As on June derivative expiry, FPI positions worth over $11 billion were outstanding in just a single stock futures segment. Of this, close to 60 per cent, or $6.8 billion worth of positions in the segment, was gross short build-up, data from ProAlpha Capital showed.

Of the net short position of over 2.86 lakh contracts that the FPIs held as on the June month derivative expiry, 60 per cent were covered till Wednesday, just a day prior to the July month derivative expiry, ProAlpha data showed. It is this massive short-covering of FPIs, a large chunk of it in P-notes, which triggered the spike in IT, banking, pharma and even other index heavyweights.

As on July 26, the net FPI short positions in single stock futures were reduced to around one lakh contracts, spiking the roll spreads in the Nifty index to 65 basis points (bps) from 40-45 bps in recent months. All major short positions seem to have been whipped out in July, which could limit any further upmove in the market. Otherwise, DIIs (domestic institutional investors) were net buyers of only ₹2,593 crore worth of stocks in July; FPIs put in ₹2,884 crore to buy stocks. Rahul Arora, CEO, Institutional, Nirmal Bang said, “There has been a drop in the rate of FII and DII inflows in the cash segment in July. The rally seems only due to short-covering, perhaps due to the SEBI circular on P-notes."

In July, the Indian market was the only one rising without any correction; other global indices in the US, Europe and Asia either remained in a tight range or fell on a month-on-month basis.

The Nifty index, which had closed at around 9,450 on June 29, rallied 570 points without any major positive news and despite fundamentals reaching levels comparable with previous crises of 2000 and 2008.

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