F&O unwinding effect continues

Unwinding of excessively leveraged positions in the derivatives markets is still having a spillover effect on the cash markets, even though investors find valuations attractive at current levels.

Amit Rathi, managing director at Anand Rathi Securities, says, "At a Sensex level of 6,700, Indian markets did not appear to be relatively cheap vis-a-vis other markets. The only driving force was liquidity. A correction was warranted. We believe that the first leg of correction from 6,700 to 6,300 was owing to profit booking by operators. This correction had a cascading effect on leveraged long positions, which forced participants to slash long positions, resulting in further correction. In the entire correction, we have not witnessed any major selling by the FIIs."

Nishid Shah, CIO at Birla Sun Life Mutual Fund, says, "The Sensex is up almost 83 per cent in the last 2 years. At higher levels, volatility is bound to increase. There has been some unwinding of positions in the futures and options segment and also small selling in the cash market. However, valuations remain reasonable at 12-13 times of FY06 earnings. The current weakness offers opportunity for long-term investors to buy stocks at value prices."

Vijay Bhambwani, director, BSPLIndia.com, explained, "The markets were in overbought zones, the F&O positions showed open interest in excess of Rs 17,000 crore. The retail segment had built excessive long positions and this is the weakest link in the chain, when markets fall. FII selling, though not heavy, was also a panic trigger for the short term players who had flocked to the markets. Once the downward spiral started, the markets being in a new trading zone, saw scepticism emerge strongly."

Deepak Chhabria, COO, institutional equity, IL&FS Investsmart, says, "The Indian equity markets had witnessed a rally based on attractive valuations and aggressive growth in corporate earnings in the second half of 2004. While initially markets were catching up with the gap in relative valuations, the upmove seen in December 2004 was essentially driven by liquidity, both overseas and domestic. January 2005 has seen history repeat itself when the rally paused initially due to lack of aggression in foreign flows and this was built into market expectations, leading to further weakness."

Gurunath Mudlapur, head of research at Khandwala Securities, says, "The rapid pace of the portfolio funds flows and the Sensex breaching 6,600 levels signalled the effect of sustained portfolio flows when there were no alternate perspective-based investment decisions. This is natural for equity markets, as movements tend to be sudden and beyond logic while assessing short term flows. For the past few months, the relative valuations of the Indian equity markets vis-a vis the rest of Asia is at a significant premium and the Indian markets have definitely been the best performing markets in Asia. Hence, there is an element of risk premium adjustment for international investors when they decide on their future allocations and moves. This is one more factor which could have precipitated a fall in the market valuations."