Stocks

As shorts hit record levels, experts feel market could reverse

PALAK SHAH Mumbai | Updated on September 04, 2019 Published on September 04, 2019

Put-call ratio at eight-year high suggests peak bearish sentiment since 2011

If the huge build-up of short positions by foreign portfolio investors (FPIs) is any indication, the domestic stock markets are likely to see a sharp reversal in trend.

FPIs, who are among the largest equity futures and options (F&O) traders in India, are holding short positions of more than one lakh contracts on the National Stock Exchange. The ‘Put ‘and ‘Call’ ratio in F&O too is at a near eight-year high, indicating that traders are most bearish on India’s markets in nearly a decade.

In the past five occasions when such build-up of shorts by FPIs was seen, stock markets witnessed a strong rally in the following weeks and months, data from market tracker indiacharts.com show. On Thursday last, the last day of the August month derivatives expiry, FPIs’ short positions in F&O stood at over 1.42 lakh contracts, a lifetime high. While the FPIs either squared-off or let nearly 40,000 contracts of their short positions expire, they are still holding nearly one lakh shorts in F&O. According to experts, this means that either the short positions could keep rising to an unprecedented level or the fall in the markets will be arrested and even convert to a short-covering rally.

The long-short data in F&O is available only from 2012. During this period, it has never been seen that the markets had not reversed the trend whenever FPI short positions crossed the one-lakh contracts mark, experts say. In 2018, when FPI short positions reached 1.34 lakh contracts, it was followed by a four-month rally in the markets.

‘Contrarian indicator’

“The point to take home is that extreme bearish sentiment on the street is a contrarian indicator.

“Such huge FPI short positions reflect the street sentiment that has recently gone to an extreme on the negative side mainly due to GDP, auto sales and IIP numbers. But traders are completely ignoring government action and the fact that markets trade on forward outlook,” said Rohit Srivastava, founder and chief strategist, IndiaCharts.

“Data show that during the last week the put-call ratio data stood at around 0.66 (66 put options for every 100 calls). The ratio is the highest since 2011 when it stood at 0.73. Holding puts reflects bearish view and an extreme reading of this shows elevated bearish sentiments,” Srivastava added.

The short-covering could have already started as the markets fell sharply on Tuesday. On Friday, the FPI short positions stood at over 1.03 lakh contracts, but as markets fell on Tuesday, the FPI short position came down to 98,599 short contracts.

Experts say, if these 98,000 contracts were to be covered, it could lead to a rally in the markets as it would lead to a massive bout of buying.

On Tuesday, the Sensex and the Nifty fell by over 2 per cent as FPIs sold stocks worth ₹2,016 crore in the cash market. The 20-day average advance-decline shows more advances than declines, indicting selling in small- and mid-cap stocks had slowed.

Published on September 04, 2019
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