Sucheta Dalal :The Bull-Bear derivative dance
Sucheta Dalal

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The Bull-Bear derivative dance  

Nov 28, 2005

The Sensex closed at an all-time high on Thanksgiving weekend, after an amazing tug-of-war between the bulls and bears in the run-up to the expiry of November futures contracts on Thursday. Clearly, the bulls emerged victorious. But for the small group of large inside players, privy to the brutal war, the developments are very worrying.


It should worry the regulator too. Unfortunately, the bull-bear tussle doesn’t ever find mention in live commentary and endless analysis on markets, because the action is controlled by a few operators and routed through a bunch of private investment companies and sub-accounts of Foreign Institutional Investors (FIIs).


However, discerning watchers find plenty of clues and evidence in the market movements. Consider the developments last week. The Sensex plunged 75-odd points each on Monday and Tuesday last week. But the real focus of the action was the Nifty, specifically Nifty Futures contracts that expired last Thursday.


On Wednesday, the bulls seem to grab the Nifty by its neck and drag it upwards sending bears running for cover. This continued on Thursday morning when the market opened with a huge upwards gap and the Sensex shot up 80 points within the first half hour. The Nifty Futures contract trades at a discount or premium to the spot Nifty depending on the market trend. As futures expiry day approaches, the premium/discount begins to melt away as there is no reason to take a big bet either way for a day or two. The action shifts to the next month through the rollover.


Interestingly, during all these months of bull market, Nifty futures have often been trading at a large discount, sometimes at 15-20 points to the index. This in itself was surprising because the Nifty should have been trading at a premium of 20 points if you factored in the normal cost of carry at 1 per cent a month.


The continuing discount was explained by market operators as a hedging by large players (shorting Nifty Futures to hedge against their long position in stocks). But something amazing happened a few days before the November futures expiry last week.


The Nifty November futures traded at a discount until November 10. From then, until November 22 it traded at the same level as the index. However, on Wednesday afternoon, November 23, just a day before the Futures expiry, it suddenly shot up and began to trade at a premium of almost 11 points.


Why should the Nifty Futures contract, which was to expire the next day, trade at such a huge premium? It can only be explained as massive short-covering by bear operators. This is an indicator of the power of the bull-charge, which propelled the Nifty to 2,608 and the Sensex to 8,638 that day.


Market insiders believe that the bears are not an amorphous and disparate set of operators who just happened to think similarly in a given trading period. The bull group is led by an industrialist with a vast bank of recently-acquired cash, in addition to several investment vehicles. The bear group is led by a controversial stock broker, who is an advisor to a clutch of hedge funds and high networth investors (all unofficially), leading them with his research expertise.


This broker was hugely and vocally bearish even when the Sensex was about to cross 7,000 and again when it crossed 8,000 and in the process lost heavily when it broke past that barrier to touch an all time high of 8,821 on October 5.


This time too, the bear group had a lot of support including from technical analysts. A technical newsletter of the brokerage Motilal Oswal openly pointed to ‘‘dangerous times’’ for the bulls. Some others believed that five major planets turning retrograde last week spelt turbulent and bearish times.


If the Nifty broke past these dire predictions and powered towards the past high, it came at a big price tag. According to a broker source, ‘‘there was plenty of evidence that the Nifty was carefully managed’’. That is why Hindustan Lever, which has big weightage in the Nifty was pushed up 2.7 per cent to Rs 176.95 on Thursday and another 5.5 per cent on Friday to 186.70. Similarly, the ICICI Bank scrip, which fell sharply after the announcement of a huge issue, bounced back. Yet, the intra-day price charts show that the rise in the Nifty, which was the key to the bulls retaining supremacy, was laboured and shaky. It was only on Friday that the Sensex and the Nifty broke out confidently.


The net positive investment by FIIs last week is usually considered a reflection of foreign confidence in the Indian market. Last week, FIIs made net purchases of anywhere between $37 million to $103 million each day but nobody is quite sure if this is genuine FII investment or is largely made up on industrialists money (and that of his friends) on a round trip.


The reason why the bull-bear war on the derivatives market never finds mention in the media is because both sides operate through FII fronts and the only information about their links to specific Indian traders is anecdotal. This is dangerous and unhealthy, because it gives speculative trading the cover of genuine institutional investment. That is why one must support the Reserve Bank of India’s (RBI) insistence that foreign investment through shadowy Participatory Notes (PNs) that allows ineligible overseas investors (including Indian money stashed abroad) to invest in India must be quickly phased out.


The regulator must also note that the bear cartel today comprises institutional entities who have no flexibility to ‘‘manage’’ the cash market by short-selling major components of the Nifty. Once Sebi allows institutional investors to short-sell, as proposed and approved by its Secondary Market Advisory Committee (SMAC), the market may be in for even more volatility. After all, the massive trading volumes in India are more a creation of arbitrageurs rather than an indicator of the depth and liquidity.


-- Sucheta Dalal