The Hindu Business Line : F&O build-up triggers meltdown

The sell-off witnessed in Indian stocks over the last two trading days, much like the correction in 2006, has its genesis in the excessive build-up in the futures and options section.

The open interest on NSE has been recording new highs ever since the beginning of this year. Investor confidence has been very high ever since the stock markets recovered from the October 2007 correction. The strength in that rebound spurred investors to roll over their leveraged positions in the expectation of windfall gains once the markets moved higher. The daily average open interest has been above Rs 1,00,000 crore ever since November 2007.

The disturbing feature in this increase in open interest is the predominance of stock futures. While Indian investors hedge through index futures and options, they prefer to buy stock futures mainly for speculation.

Moreover, in a booming stock market, these positions tend to be mainly long (buy) positions.

Holders of these long positions, rushing towards the exit door appear to have caused the exaggerated fall on Monday.

New products such as the mini Sensex and Nifty future and futures on various indices such as junior Nifty and CNX 100 and the additions to single stock futures may have also encouraged retail investors’ participation in the derivatives segment.

Retail Investors

Data released by NSE shows that retail investors account for over 65 per cent of the daily traded turnover in derivatives.

These investors would be the hardest hit in Monday’s meltdown since they have lower holding capacity and need to cut losses faster.

With eight more sessions to go for the expiry of the January contracts, it is unlikely that all the loss-making positions have been liquidated. Unwinding of these positions can thwart any recovery from hereon.