Why Nifty discount is widening sharply ?

FIIs buying spree is likely to continue in March due to reverse arbitration, leading to rise in discount of Nifty futures from spot Nifty.

Foreign institutional investors (FIIs) who have bought Indian equities worth about Rs 5,600 crore in the past three trading sessions is likely to continue its buying spree this March, as FIIs that are running proprietary books were seen unwinding their reverse arbitrage positions from the markets, on account of 10% tax on dividend income, as announced in the Union Budget.

Traders are anticipating that many Nifty companies with high promoter holdings such as RIL, Sun Pharma, Wipro and others may prepone their annual dividend announcement to this March to avoid additional tax burden.

Nifty futures which was trading about 20-25 points premium before the Union Budget, is currently trading at 27.65 points discount to spot price, which is about 50 points drop from the pre-budget levels. Analysts said current discount of Nifty futures may expand to 75 points as companies from the index may consider dividend in March series.

Nifty futures always trades at ex-dividend basis, hence as soon as companies start declaring dividends the negative gap with cash market is expected to increase. Nifty closed 106 points or 1.45% higher at 7,475 on Thursday, whereas Nifty March futures ended 86 points or 1.17% higher at 7,447. However, Nifty April futures is currently trading at par with the spot index

“It has been observed that foreign institutional investors who were engaged in reverse arbitrage trade before the Union Budget are now unwinding their market positions,” said Sudip Bandyopadhyay, equity investor and promoter, Juno Moneta Technologies from Singapore. “The sharp recovery in Nifty stocks over past few trading sessions can be partly attributed to unwinding in reverse arbitrage positions.”

FIIs this year so far have sold Indian shares worth Rs 13,628 crore before resuming buying this week post Union Budget, where the government announced fiscal deficit target of 3.5% of GDP for year ending March 2017, raising hopes of interest rate cut by the Reserve Bank of India in the forthcoming policy meeting.

In reverse arbitrage process a trader simultaneous purchase and sale shares, aiming to profit from mispricing available in futures and cash market. A trader sell stocks in cash market and assumes opposite position in futures of same stock to capture the price difference between the two markets. In stock markets when dividend is announced the stock price goes up by dividend amount and on ex-dividend date the price reduces by same amount.

“We are expecting strong dividend announcement from companies such as Reliance Industries, Sun Pharma, TCS, Infosys, Wipro, Bajaj Auto, Hero Honda and Coal India,” said Hemant Nahata, head of derivatives at India Infoline. “These companies have significant FII holdings and unwinding of reverse arbitrage positions can be seen in many counters.”

In securities lending and borrowing (SLB) market the number of stocks available for trade has dropped 30% to 74 stocks in April series, compared to 107 stocks in March series. This shows that traders fading away from constructing reverse arbitrage trade as many companies are expected to announce their dividend over next coming weeks.

However, market expectations in terms of dividend announcement is relatively low from PSU banks and metal companies which are reeling under pressure on account of lower profitability.

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