Suresh Krishnamurthy

How would you interpret the recent trends in open interest positions of FIIs given the presence of large buyers in market? — Prasanna K. Barik

Data on open interest do not offer any definitive clues. When open interest positions rise, it is not clear if short positions rose or long positions rose. Ditto when they decline.

This would apply to data on open interest positions of FIIs also. From a host of other factors we can only surmise as to what happened.

Foreign Institutional Investors are generally big players in the spot market. From available data, they are probably the only players in both the spot and derivative markets.

It is thus possible that their interest stems from their desire to hedge their open positions in the spot market. If this is true then a decline in open interest positions is possibly an indicator of bullishness.

This, however, may not be true always. For instance, if FIIs have already liquidated their open positions in the spot market, they would close their position in derivatives as well. In that kind of a scenario, a decline in open interest positions is not an indicator of bullishness.

It is then probably an extremely negative signal.

Things get even more complicated if FIIs are not mere hedgers but are also arbitrageurs and traders in derivatives. Then, the trends need to be interpreted in a manner similar to how the broad market trends are. For instance, a rise in open interest positions along with a rise in prices indicates bullishness.

That they are big players in futures suggests that they trade, rather than hedge, in derivatives. This is because most informed investors use options to hedge. Since futures prices move in tandem with spot prices, futures are used to build positions in anticipation of a rally.

Let us also consider the statistics on open interest positions of FIIs. They have generally not been big players in stock options and therefore let us consider the other three types of contracts — Index futures, index options and stock futures. Data since Oct 1 indicate that:

*Index futures open interest has remained almost unchanged

*Sharp rise in open interest in index options

*Doubling of open interest in stock futures

The unchanged open interest in index futures despite a strong rise in index values since October 1 prima facie indicate that they are not that bullish about a further rise in index values.

They, however, appear to be more bullish on individual stocks. In a rising market, select stocks out perform indices.

It thus makes sense to invest in stocks rather than indices. In this backdrop, strong rise in stock futures' open interest suggest that a small rally may be in the offing.

They could also have been buying out-of-the-money index options.

There is also another piece of evidence that ties in with such an assessment. FIIs have been big buyers in spot markets as well during October and November.

Buying most of what they want from the spot market may spark a large rise in stock price. So if FIIs buy part of what they need from spot markets and buy stock futures, they may be able to implement their views at a lower cost.

The limits on FII acquisition in specific stocks are another factor. For instance, previously, FIIs used to accumulate long positions in SBI in the futures markets since the limit for FII investments in the spot market had already been reached.

This view is, however, still only a surmise. Other data, especially that relating to implied volatility, may need to be looked into to confirm this view.

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