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Open positions signal market risk

business Updated: Jul 27, 2007 01:13 IST
Vyas Mohan
Vyas Mohan
Hindustan Times
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With benchmark equity indices inching towards another milestone, active hedging and higher contract prices saw the derivatives segment of the National Stock Exchange (NSE) clocking a record high turnover. On Thursday, the day of settlement, contracts worth a total Rs 79,995.85 crore changed hands in the derivatives segment of the NSE, while the cash segment recorded a turnover of Rs 15,475.84 crore.

Though the dramatic spurt in total traded value in the derivatives segment may be attributed to the obvious--a high position build-up in the July series and costlier contracts--the trend is a cause for worry, say market experts.

“The number of positions was heavy and thus the turnover was high on settlement day. More the position, more the risk,” said Anil Gupta, additional vice-president (derivatives), Religare Securities.

A big build-up in open interests is worrisome for investors. This is because positions in the derivatives segment are highly leveraged and a movement on the index or the stock against the largely expected direction could generate margin calls (the requirement to pay up for the drop in prices of the contract held), which if not met, the stocks will have to be sold. Such situations trigger massive selling in the market, thus resulting in a crash, like in May 2006.

Market participants say that open interest positions may be as high as 80-85 per cent of the total contracts traded, which means 80-85 contracts out of the 100 traded remain open. An open position is an existing directional call on indices or stocks.

The reason for the frenetic activity in the derivatives segment is that the big players in the market, foreign institutional investors (FIIs), are actively hedging their cash market positions by taking an opposite position in the derivatives market.

“FIIs are understood to be buying in the cash segment and selling in derivatives. And obviously, there are many new entrants in the NSE futures and options basket, which is also a reason for the higher turnover,” said Jitesh Ranawat, derivatives analyst of Pranav Securities.