Foreign sell-off of futures shows Nifty rebound: IIFL

Equity futures are signaling a bottom for stocks after foreign investors pared exposure to the contracts to the lowest level in six months, according to IIFL Holdings.

Foreigners cut holdings of futures on the Nifty index and local stocks to Rs 73,200 crore ($11.5 billion) in notional value on May 12, the lowest level since October 20, according to data compiled by Bloomberg. Their open interest in the futures market has dropped as much as 31 per cent since March 3, when the Nifty rose to an all-time high. The stock gauge has since dropped as much as 10 per cent to enter a correction.

"In the past three years, a decline in futures positions held by foreigners has led to a market reversal," Hemant Nahata, a derivatives analyst at IIFL in Mumbai, said in a phone interview. "We expect foreigners to start buying cash equities and add to long positions on index futures."

Foreigners' short positions were 67 per cent higher than the 18-month average as of May 15, reaching a level where the Nifty index tends to rebound as positions are reduced, Nahata said. Foreign institutions have a significant influence in derivatives trading in India, holding a long or a short position in 36 per cent of the total number of contracts as of Tuesday, according to stock exchange data.

The Nifty has risen three per cent this month on speculation the central bank will reduce borrowing costs. Consumer prices grew 4.87 per cent in April from 5.17 per cent in March, offering central bank Reserve Bank of India Governor Raghuram Rajan more room to lower interest rates for a third time this year. RBI's next policy meeting is on June 2.

"Foreigners are likely to cover their short positions on expectation of a rate cut," Suniil Pachisia, vice president at Pratibhuti Viniyog, said in a phone interview. "We expect consolidation with upward movement."

Foreign investors have been net buyers of Nifty futures over the last two days, data compiled by Bloomberg shows. The India VIX index, a benchmark gauge of option prices, slid three per cent to 17.72 at the close in Mumbai, its lowest close since May 5.