Derivative shorts, at a six-year high, holds an important signal

The holdings of Nifty and Bank Nifty futures and options stand at a net short of 447,593 contracts on Wednesday. This was the highest quantum of net shorts since 21 November 2016, when they held 512,535 contracts the month when India scrapped 87% of its currency.

“Reasons could be foreign funds finding a way to relatively cheaper EM markets like Hang Seng and Kospi over the past few months, a weaker currency and the Adani crisis adding fuel to the fire,” said Rohit Srivastava, founder of IndiaCharts, who cited the data.

The Indian bellwether Nifty 50 has fallen 7% from its record high of 18,887.6 on 1 December to 17,554.3 on 22 February. In the past three months through 31 January, MSCI India has given a negative 3.48% return against a 22% gross return generated by the MSCI Emerging Market Index.

EM indices like Hang Seng and Kospi are down 13-14% from their all-time highs, reflecting their cheaper valuations compared with India’s Nifty, which has been held by a superlative performance by banks.

To be sure, huge FPI short positions also preclude a huge fall, according to anecdotal evidence, as any positive trigger could result in a massive short-covering rally.

“Pinning the reasons for the shorts can be quite a challenge …. could be a hedge against their cash portfolios or simple arbitrage positions,” said Andrew Holland, chief executive of Avendus Capital Public Markets Alternate Strategies. “That said, such huge shorts, while underscoring caution, could result in a short covering induced rally on a hint of positive news, globally or domestically.”

On 21 November 2016, FPIs’ huge net index shorts coincided with the Nifty making a low of 7,916. These were covered, and the investors initiated net longs of 64,538 on index derivatives, taking the Nifty to 8,982 by February end.

The netting off is achieved by calculating the difference between the bullish and bearish positions on index derivatives—long futures plus long call options plus short puts minus short futures plus short calls plus long puts.