Profit-booking dragged Sensex down last week

Thanks to Friday's sharp rally, the Sensex closed one of the most volatile weeks in recent years with a net loss of just 130 points.

The markets crashed three days out of five last week amid sundry fears and rumours, including a ban on participatory notes (PNs), the unwinding of positions in the F&O segment and hefty selling to pay for additional margins.

As a result of the confusion, the BSE Sensex lost 470 points up to Thursday before Friday's 222- point recovery saved the day. So what caused the extreme volatility? Was it PNs? The F&O unwinding? Or something more sinister?

A section of the market feels that though the regulator's stance on PNs was indeed a cause for concern, the more fundamental reason for the steep falls on three days was pure and simple profit-booking. Most operators know that the market is overheated and thus began selling stocks.

Says Deena Mehta, managing director, Asit C Mehta Investment Intermediaries: "A correction on the back of profit-booking at higher levels was expected. It is just that when it finally happened, the market panicked, looking for reasons to justify the fall."

The sharp spike on Friday also proves that for every player who needs to book profits, there are others with contrarian views.

Says Pradip Doshi, of Pradip C Doshi Stock Brokers: "The increased volatilitry last week proved that there are new players with different views in the market. This shows that the Indian markets have matured and there is lot of depth."

Despite worries about foreign institutional investors (FIIs), the fact remains that they have been net buyers in 2004.

Market sources indicate that even as the older set of FIIs are cashing in their gains after a spectacular run in 2003, new money is coming in.

Net FII inflows totalled Rs 2,867.4 crore in the equity markets till January 24. If the trend continues through the year, total net FII inflows could touch the Rs 100,000 crore landmark soon. The total currently stands at Rs 96,970.6 crore as on January 21, 2004.

According to the broking head of a leading brokerage, the volatility in the market during the last three days was partly due to the over-leveraged positions in the futures segment.

Says Suhas Naik, equity fund manager, IL&FS Mutual Fund: "Last week's volatility was more of a spiral effect. Arbitragers who had built up positions in the derivaties market were running to reverse their positions in the cash market."

The intra-day volatility - where sharp increases in early trading is followed by sharp falls later on in the day - is also explained by the "morning effect" when new funds buy Nifty (stocks) in a basket through programme trades.

The crash in the latter part of the day is explained by retail investors, "who are selling in large numbers."

A dealer in a brokerage also confirms that retail investors are indeed selling mid-cap stocks. "The FIIs are on the buy side, especially the newer lot who are coming in. But we have retail investors on the sell side."

Vijay Bhambwani, technical analyst and chief operating officer of bsplindia.com, says "The implied volatility in the derivative markets has jumped significantly in the last 10 days, indicating that traders are taking a high degree of short-term view on the market."

Interestingly, the implied volatilty in Nifty puts has jumped 50 per cent in one week and around 35-37 per cent on calls. Implied volatility measures the market's perception of the volatility of the underlying security.

"Traders had built up huge sell positions over the last three trading sessions, but these positions were covered up on Friday. The biggest positive development now is that traders have now started rolling over positions into the February series."