Why FII play is crucial for the F&O market

Over the last few years, FIIs? share has risen to a third of the F&O segment

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The foreign institutional investors (FIIs) play in the futures & options (F&O) segment is crucial for Indian markets, including in terms of setting the short-term trend. Until February, their share was on the rise, accounting for a third of daily contracts (index and stock futures and options) traded on the NSE. Notably, since it has been proved decisive in the last couple of years to predict the undercurrent of the market, many traders and investors track it keenly.

Siddhartha Bhamre, head- equity and derivatives, Angel Broking, says, “F&O trades have become lead indicators for the market as they are interested in returns month on month. Apart from looking at leverage levels, traders also see when FIIs are long with huge positions, as any small negative news leads to unwinding and vice versa. Unwinding of long positions in F&O also puts pressure on the cash market even if there is no actual selling happening in a big way.” That apart, FIIs’ play in derivatives also leads to arbitrage in the cash market, he adds.

Among key reasons for the rise in FII activity in the F&O segment are the higher returns. Bhamre says, FIIs are mostly based out at Europe and the US, see lucrative opportunities. The F&O segment has given returns of around eight per cent, going by the premiums prevailing in the derivatives segment, over the cash market. “These returns are substantially higher from their home market fixed income returns. There are several such FIIs interested only in derivative deals,” he adds.

Apart from higher returns, the rise in FII activity in F&O segment is also partly due to the depth in the cash segment, which is not big enough to absorb high volumes. Thus, FIIs, with strong back-up of significant holding in most index heavyweights from banking, software and automobiles sectors, have raised their play in the F&O segment rather than buying heavyweights in the cash market.

Had it not been for the higher activity in the F&O segment, Indian markets would have been more volatile. The price sensitiveness of the cash segment vis-a-vis buying and selling by FIIs can be gauged from past trends. FIIs were net sellers in the cash market worth Rs 1.1 lakh crore during the global economic crisis of 2008-09. The market crashed in that period, with the Sensex falling over 60 per cent from its peak of 21,207 on January 10, 2008. While the successive reversal of outflow saw the Sensex revisiting its highest level on November 5, 2010, the market again moved down by 29 per cent on subsequent outflow led by the weakening world economy due to the debt crisis (in 2011).

Meanwhile, barring the uncertainty over tax issues, 2012 has started on a good note. FIIs are net buyers and the Sensex has edged up from its 2011 low and is now hovering at around 17,000 levels. FIIs’ play in F&O in 2012 has been 8-10 times their turnover in cash market, up from five to seven times during April-October 2011.