What fuels rally in Sensex, Nifty? More than domestic buying, short covering due to Sebi's P-note ban in F&O

Bulls may have finally taken some breather on the stock bourses in today’s trades, with Sensex tumbling 0.5 percent or down 167 points at 32,218, while the broader Nifty easing 0.4 percent or down 38 points to slip below the crucial 10,000-mark at 9,982. However, incessant gains in last few sessions propelled both benchmark Sensex and Nifty to scale historical highs on Thursday, which also marked the expiry of the current month’s derivative contracts.  On Thursday, although Sensex gave away all its gains towards the close due to late profit-taking, the index hit a fresh life-time high of 32,672.66. Similarly, Nifty also breached 10,100-mark for the first time before ending on a flat note. So, what was the reason that led to a spectacular rally on the local bourses, especially, when global markets have been mostly range-bound with a negative bias during the month so far? Reports suggest that more than the fundamental reasons, the upsurge was the result of short-covering in equity stock futures. Following the expiry of June derivative contract, both the key benchmark indices shot up around 6 percent in the current month. Heavy short-covering by investors can be attributed to the recent ban on any fresh issuances of P-notes on derivatives by Sebi, besides also ordering the unwinding of the existing contracts. “Of the net short position of over 2.86 lakh contracts that the FPIs held as on the June month derivative expiry, 60 percent were covered till Wednesday, just a day prior to the July month derivative expiry, The Hindu Business Line report said citing data from ProAlpha.

Notional value of ODIs/P-notes  on derivatives in Rs crore Infogram

Further, FPI short positions in single stock futures fell to around one lakh contracts, spiking the roll spreads in the Nifty index to 65 basis points (bps) from 40-45 bps in recent months, the Business Line report said. Hence, reports of strong domestic buying aiding the sentiment seem to be over-exaggerated as domestic institutional investors were net buyers of only Rs 2,593 crore worth of local stocks in the current month. “There has been a drop in the rate of FII and DII inflows in the cash segment in July. The rally seems only due to short-covering, perhaps due to the Sebi circular on P-notes,” HBL report said quoting Rahul Arora, CEO, Institutional, Nirmal Bang. On the fundamental side, most of the country’s macro growth factors are in a sluggish zone; GDP growth in FY17 slowed down to around 7 percent from around a healthy 9 percent level; banks’ non-performing assets continue to baloon due to rising loan defaults by small, medium and few large companies; corporate earnings remain sluggish and the job market scenario is looking gloomy with the demonetisation exercise in November last year further worsening the sentiment.