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Lokeshwarri S.K.

BL Research Bureau The derivative segment of the National Stock Exchange is showing signs of overheating even as the Nifty is crashing past one milestone after another.

High open interest, predominance of stock futures and surging turnover in this segment points towards trading action nearing a crescendo.

Open interest (the number of contracts that are not squared at the end of a trading day) on the NSE has been soaring higher by the day and the value is currently above Rs 1 lakh crore at Rs 1,17,061 crore (September 22, 2009).

The last time such a high open interest (OI) figure was recorded was in December 2007 when the four-year old bull market was at its peak.

Surging open interest reflects the growing confidence of investors in the sustainability of the rally and typically complacency is at its highest near market peaks. Increased leveraged positions are also a detrimental to any rally since unwinding of these positions in corrections tends to deepen the decline.

Interestingly, the number of contracts currently outstanding as open interest at 44,65,326 is nowhere close to the levels recorded in the last quarter of 2007. This figure is even below the high recorded this January at 49,66,471.

Turnover in the derivative segment of NSE is also nearing levels recorded in the last quarter of 2007 when bulls were on a rampage. Turnover in this segment was Rs 91,178 crore on Wednesday.

The only month when derivative turnover exceeded Rs 1 lakh crore was in October 2007 when volatility was high following the imposition of restrictions on offshore-derivative instruments.

Another data that is flashing red is the surge in the open interest in stock futures.

In Indian markets, these instruments are preferred by retail investors to trade in futures and options. These investors typically have lower holding capacity and tend to panic easily.

OI in stock futures was at its highest in January 2008 at Rs 81,000 crore. As the crash of 2008 progressed the OI fell to Rs 11,200 crore by October 2008.

It is observed that open interest in stock futures has crept up to Rs 33,373 by September 23 indicating that retail investors are once again getting sucked in to leveraged trading.

Index put-call ratio based on volume has risen to 1.77 currently. But this is not a cause for worry since PCR is a contrarian indicator.

High PCR is a bullish sign as bears tend to outnumber bulls near market lows and vice versa. Higher puts can lead the market higher as bears cover their positions.

A similar situation prevailed towards the end of March, 2009. The PCR rose to 1.95 then. But instead of the rally ending, it continued to power ahead in April and May.

More Stories on : Stock Markets | Derivatives Markets

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