Stocks

F&O indicators signal lack of froth in market

| Updated on February 22, 2011 Published on February 21, 2011

Union Budget is one of the most anticipated events in Indian traders' calendar. Trading activity typically spikes up around this time as positions are taken in anticipation of budget proposals. Though turnover is at record highs in the run-up to the Union Budget this year, other indicators such as open interest, put-call ratio signal a cautious stance among traders.

Derivative turnover

Derivative segment in the Indian stock market is growing by leaps and bounds. From a daily turnover of less than Rs 1,000 crore in 2002, it averaged Rs 1,38,000 crore in 2011. Surprisingly the correction in the market since November has not affected the traded volumes much. Though the daily traded volume crossed Rs 2,50,000 crore twice in October and November last year, monthly average in these months was around Rs 1,38,000 crore, that is, the same as the average turnover recorded since the beginning of this year.

Despite traded volume in the futures and options segment remaining robust, the open interest (the value of futures and options contracts not squared at the end of a trading day) is not growing at the same pace. While the value of open interest crossed Rs 2 lakh crore in September, it is currently about 24 per cent below its peak value at Rs 1,58,000 crore.

The inference that can be drawn from this data is that though traders are trading heavily during the day in the derivative segment, they are not willing to carry forward their positions and hence are squaring up their position towards the end of the trading day.

Composition of OI

If we compare the composition of open interest at the November peak to now, a significant reduction is seen in the open interest in stock futures.

These comprised about one-third of the outstanding contracts in the first week of November. This figure is currently down to 22 per cent.

Reduction in outstanding stock futures reflects the lower participation of retail investors in the derivative market.

These investors could have turned cautious following steep declines in the prices of some of the mid- and small-cap stocks and could have reduced their exposure.

The proportion of index put and call options is conversely higher now. It is interesting to note that value of outstanding index call options is nearing its peak value recorded in October and November despite decline in Nifty value. Since only the more mature traders dabble in options, increase in the outstanding position of these instruments is not disconcerting.

Put-call ratio

Ratio of outstanding put options to call options or the put call ratio (PCR) is also very low near the lower end of its long-term band at 1.07. When this ratio declines to 0.80 it denotes an extremely oversold market whereas PCR above 1.6 means that market is overbought and ripe for correction.

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Published on February 21, 2011
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