What F&O Market Points To After Friday’s Bear Squeeze

India’s equity benchmark capped its worst week in a decade with a bear squeeze as stocks rebounded on Friday. And more of that may be in store as there's still a buildup of shorts in index futures.

Nifty 50 swung more than 1,500 points in a day on Friday. It dropped early to hit a lower circuit, but recovered losses after the trading resumed to end more than 3 percent higher. That came as domestic investors, taking cues from a rebound in Dow Futures, a recovery in Asian markets and a strengthening rupee, started buying after the 45-minute halt. That caught shorts in the derivative market off guard and they started unwinding positions to cut losses, aiding the rebound.

Short Covering

Driven by panic of virus outbreak, Nifty 50 tumbled from 12,000 to 8,500 in 14 days as foreign investors withdrew money and short positions built up in the derivatives market. The surprise recovery on Friday caused a bear squeeze—when short sellers are trapped in a rising market and begin to buy to pare losses.

Banking futures saw the maximum short-covering with the open interest, or the number of outstanding contracts, dropping by more than fourth, according to National Stock Exchange data.

Foreign institutional investors unwound shorts on index futures by 36,000 contracts and on stock futures by 38,000 contracts, according to data on the NSE. But FIIs are still short on index futures with 1.1 lakh contracts, while they are holding more long contracts on stocks.

Since foreign investors have been selling in the cash market, their view on India hasn't changed yet. But if the short-term sentiment leads to buying in the cash market, that could lead to further short-covering on Monday.

Index options data shows a mixed picture as FIIs bought calls indicating bullishness, but also wrote calls suggesting that the upside could be capped.

Data seems to be all over the place due to volatility, according to Chandan Taparia of Motilal Oswal. Open interest is scattered and shifted at various strikes as many put writers got trapped in recent market fall and unwinding pressure could keep the street under the pressure, he said.

Call writing is seen at 9,500 strike, while put writing is seen at 8,500 and even sliding lower day by day with the lower market range, he said, adding that data suggests trading range between 9,500 and 10,500 zones.

Overall, FIIs sold Rs 6,027 crore worth of stocks, pulling out money for the fourteenth straight session, while domestic institutions bought Rs 5,897 crore worth of equities in the cash market.

High Volatility A Concern

Nifty closed with gains on Friday but India Volatility Index also ended 25 percent higher at 51, still trading close to 2009 highs. That suggests it’s still too early to decide if Nifty has bottomed out.

VIX beyond 50 zones suggests that volatile swings could continue in the market, Taparia said. Volatility has to cool down from current multiple years high zones then only stability and smooth ride could be back in the Indian market, he said.

Levels To Track

Hemant Thukral, head of derivatives research at Aditya Birla Capital, said the VIX suggest wild swings with support at 9,000-9,400 band and immediate resistance at 10,150. If Nifty can close above 10,150 in coming days, then resistance shifts to 10,500, he said.

With FIIs in short-covering mode, investors could consider buying on dips around 9,400-9,300 with a stop loss at 9000 and a target of 10,200 -10,500 on Nifty, he said.

According to Taparia, the Momentum Oscillator RSI turned northward from deep oversold territory, showing some sign of relief for bulls. Nifty has to continue to hold above 9,400 to witness a bounce back towards 10,333-10650.

While key support exists at 9,400 and then 9,100 levels, he advised traders to remain light on positions citing volatility at multi-years high across the globe.