Coming up, a bear-trap or a bull-massacre

High leverage in single-stock futures can create large volatility in the broad market.

The derivatives market is seeing concentrated arbitrage and speculative action in single stock futures, while index futures are being largely sidelined. Single stock futures account for over 65% of the weekly derivative trading volumes, while index futures account for just around 25%.

Two months ago, index futures accounted for as much as 35% of weekly derivative trading volumes while single stock futures accounted for 55%.

The increase in single stock futures activity indicates that liquidity flows are largely concentrated in specific stocks that offer cash futures arbitrage or are highly speculative in nature. Single stock futures of newly listed companies like GMR Infra, Lanco Infra and Parsvnath have seen a surge in volumes and open interest. Stock futures of Siemens, IVRCL Infrastructure, Century Textiles and Reliance Communications have been consistently coming in the top five weekly traded contracts.

The high leverage in single stock futures has the potential to create large volatility in the broad market as liquidity dries up in stocks that do not have large floating stock. Many of the stocks mentioned above either have floating stock of less than 20% of their market capitalisation or have an uneven distribution of shareholders. This drying up of liquidity can create large movements in prices of the stocks and this could have a cascading effect on the broad market. The market is looking poised for a bear trap or a bull massacre.

Top five traded single stock derivative contracts

The top five traded single stock derivative contracts for last week were Reliance, SBI, Siemens, IVRCL Infra and Century Textiles. Siemens and Century Textiles replaced Tata Steel and GMR Infra in the top five traded single stock futures last week from the week before last.

Reliance stock futures price was flat week-on-week, while open interest was higher by close to 15%. Open interest in Reliance stock futures has increased by 20% over the last two weeks, while carry is over 11%. The increase in leverage is largely due to cash futures arbitrage and a decrease in carry could see the stock price under pressure. SBI stock futures price lost around 1.4% week-on-week, while open interest was higher by over 9%.

The stock futures price will come under pressure as the market sells its long positions and goes short on SBI given the cash reserve ratio hike by the central bank.
Siemens stock futures price came off by around 1.7%, while open interest was higher by close to 6%. The counter has seen a good build-up of arbitrage and speculative positions given the carry of over 12% and the flow of liquidity into infrastructure stocks. Open interest has moved up by almost 300% over the last one month. The high leverage will make the stock futures price extremely volatile, given its lower-than-expected earnings numbers for the fourth quarter.

IVRCL Infra stock futures price came off by close to 10% week-on-week, while open interest was higher by 86%. The large increase in open interest amidst a sharp fall in price is expected to lead to higher volatility in price. The stock could see large price movements in either direction in the coming week.

Century Textiles stock futures price gained 1.5%, while open interest was higher by 24% week-on-week. The stock futures are seeing a good build-up of leverage on the back of the company’s real estate plans. The stock futures price will be volatile this week, given the increase in leverage.

Nifty index futures

Nifty index futures price lost around 1.25% week-on-week, while open interest was higher by 17%. The index failed to sustain at higher levels and after touching all-time highs of 4,046, the index lost ground by 2.4% on the last day of last week. Nifty index futures price could come under pressure in the coming week given the doubts on sustainability of the index at higher levels.

Nifty index options

Nifty index options saw call option premiums lose around 35% across strikes, while put option premiums gained around 10% across strikes as the market came off from all time highs to close the week with a 1.25% week-on-week loss. Implied volatility (IV) was steady for calls and puts with call IVs closing last week at 21%, while put IVs closed at 23% levels. Open interest was higher across contracts with the call and put 4000 strike showing the highest increase in open interest. Nifty put options may see increase in implied volatility in the coming week given the fall in the index last week.

FII activity

Foreign institutional investors (FIIs) were net sellers in Nifty index futures for Rs 1,403 crore last week against net sales of Rs 1,084 crore in the week before last. FIIs have sold over Rs 2,400 crore in index futures over the last two weeks, indicating short positions being created at higher levels of the market. FIIs were net sellers in single stock futures for Rs 522 crore last week against being net sellers for Rs 2,746 crore in the week prior to last week. FII activity indicates directional positions in the index and arbitrage positions in single stock futures.

Product-wise traded volumes

The daily average volumes in the derivative market was lower last week at Rs 26,739 crore against Rs 35,518 crore recorded in the week before last. Nifty index futures accounted for 24% of total daily average volumes, while single stock futures accounted for 65% of total daily average volumes. Nifty index futures is likely to see higher volumes in the coming week as the market speculates on the direction of the broad market, given its fall from all-time highs.

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