Market to gap up as F&O bears dive for cover

The Sensex, which, unlike the Nifty, missed reaching a fresh high last week, is expected to test its previous record on the bullish sentiment.

The outcome of the state elections–with the BJP leading in Rajasthan, Madhya Pradesh, and Chhattisgarh–reinforces the likelihood of the political party winning the national election next year, say analysts.

Foreign portfolio inventors (FPOs) held net short futures positions of 47,161 Nifty and Bank Nifty contracts, and net long index put options totalling 240,625 contracts. Analysts expect them to now cover at least some of their short futures positions and reduce their puts. Short-covering refers to buying back contracts sold earlier.

In addition to this, retail and so-called high net worth, or wealthy, investors have been sellers of Nifty and Bank Nifty call and put options. They will have to close out their short positions in Nifty and Bank Nifty calls, which will lend momentum to the rally.

The combined value of 20,300 weekly call and put options–weekly expiry typically happens every Thursday–sold by proprietary traders and HNI clients was about Rs233 a share, with 50 shares making for one contract. 

This baked in volatility of 2.3% on the up and downside from the 20,300 level, with the Nifty likely to range between 20,067 and 20,533 points on Monday.

Derivatives heads of research at leading brokerage firms expect a gap-up opening to be aided by short-covering of futures contracts by FPIs and call sellers who have net sold calls at 20,200 and 20,300 levels, and possibly at the 20,500 level.

Nifty closed on 1 December at 20,267.90 points, after hitting a fresh high of 20,291.55, surpassing its previous record of 20,222.45 on 15 September. The Sensex could reach a fresh high on Monday, after having fallen short of its 15 September record of 67,927.23 points by just 0.7% on Friday, closing at 67,481.

“The markets will now price in a clear mandate for the BJP at the Centre next year, which will add more steam to the rally,” said Chandan Taparia, head, derivatives and technical research at Motilal Oswal Financial Services. 

“While markets could see fresh institutional and retail buying of CPSEs (central public sector enterprises), the rally to new highs of 20,500 and 20,750 will be aided by short-covering by FPIs and call-options sellers.”

NSE data show that retail and HNI clients as well as proprietary traders were cumulatively net short index options, while FPIs were net long both on calls and puts. While some of these positions are hedges, others were initiated just ahead of the election outcome. 

Clients were cumulatively net short by 19,484 on Nifty and Bank Nifty call options contracts on 1 December, while proprietary traders were net short by 34,964 contracts. FPIs were net long by 54,447 contracts. 

Call options buyers buy calls on bullish expectations, while put options buyers buy on anticipation of a correction. Both these buy from options sellers in exchange for a premium. If the market rises, calls rise, earning gains for options buyers and resulting in losses for options sellers.

Losses for call sellers, however, will be somewhat offset if they have also sold index puts. A call seller tends to be bearish, while a put seller is bullish. 

So far this year, while FPIs have net purchased shares worth Rs1.14 trillion, domestic institutional investors have net bought Rs1.73 trillion worth of shares.

In addition to the capital markets segment, these market participants use the derivatives segment, principally weekly options, to hedge or punt on events such as elections or RBI policy meetings.

Analysts expect market concerns surrounding next year’s general election to abate. But the market will expect tighter fiscal measures from the government. 

“The market will put behind fears of an electoral upset in 2024, with continuity being reinforced,” said Shyam Sekhar, market veteran and founder of ithought advisory. 

“For the public mood to change significantly between now and next year, there has to be a drastic economic or political event, both of which look unlikely,” Sekhar added. 

“However, the government, post the national election, will have to tighten its fiscal purse strings, which were loosened due to Covid, in order to raise revenue and sustain investment. The market will begin pricing that over the months leading into the elections.”