What Is Long Unwinding In The Stock Market?

What Is Long Unwinding In The Stock Market?

What is long unwinding in the stock market: The stock market is a place where there is continuous buy and sell transactions taking place. The price is pushed upwards while the buyers have the upper hand and the price falls when the sellers have the upper hand. 

In this article, we will discuss, what is long unwinding in the stock market and also discuss short covering

Basics You Need To Know

Let us understand a few of the basic terminologies before we understand what is long unwinding in the stock market and short covering in the stock market.

What Is A Long Position?

Buying security with the hope that its price will rise in the future is referred to as taking a long position. You, therefore, own the security with an expectation of Bullishness in the market.

What Is A Short Position? 

A short position refers to an individual selling a security that they do not own. An asset is shorted with an expectation of its price decreasing in the future. 

What Is Open Interest?

Trading in futures and options requires you to enter into a contract with another party. Open interest tells you the number of contracts that are held in the market or are outstanding. It helps you in identifying the bullish or bearish sentiments on a particular asset.

What Are Long Unwinding And Short Covering In The Cash Market?

A long unwinding in the cash market refers to the long positions exiting their positions and squaring them off. It is marked by the fall in the price of the security along with the decrease in the number of buyers.

A short covering refers to short positions getting exhausted in the market. This means the sellers are getting exhausted. It is marked by the rise in the price of the security along with the decrease in the number of sellers. There is an expectation of bullish momentum in the market.

What Are Long Unwinding And Short Covering In The Futures Market?

Now that we have understood long unwinding and short covering in the cash market. Let us understand these concepts in the futures market.

Long Unwinding In The Futures Market

The long build-up in the futures market indicates that the bullish sentiment on the underlying asset is getting exhausted. Here, the individuals are squaring off their long positions in the futures market.

During a long unwinding, there will be a fall in the price and also a decrease in the number of open interest for the futures contract for that particular underlying asset. A decrease in the open interest would imply that more buyers are going out of the market.

Short Covering In The Futures Market

Short coverage in the futures market indicates that the bearish sentiment on the underlying asset is getting exhausted. Here, the individuals are squaring off their short positions in the futures market.

During a short covering, there will be an increase in the price and a decrease in the number of open interest for the futures contract. A decrease in the open interest would imply that more sellers are going out of the market.

Long Unwinding In The Stock Market

On the NSE website, you may readily acquire information about the price and open interest. At the end of each trading day, the open interest will be updated, and depending on the change in open interest and price, you may be able to understand the zone of demand and supply.

Let us understand long unwinding and short covering in the futures market with the help of an example:

Suppose the Nifty futures are currently trading at 17000 points and the open interest is 10000. Let us see how long unwinding and short covering occur when the nifty futures and open interest change with respect to the current levels

Market MovementFuture Price% increase in priceOpen InterestChange in OIUnwinding/CoveringMarket View
Current level1700010000Neutral
Case 116660-2%7900-2100Long unwindingBearish
Case 2173402%8000-2000Short CoveringBullish

(Both the cases mentioned above are independent of each other)

Case 1: In this scenario, you can see that the price of the futures contract has decreased and even the open interest has come down. This indicates long unwinding and this implies that there is a bearish view in the market.

Case 2: In this scenario, you can notice that, while the price of the futures contract is increasing, there is a decrease in the open interest. This indicates a short covering and possible bullish sentiment in the market.

Long Unwinding And Short Covering In The Options Market

In an options contract, you can enter the position in four ways. By taking long positions in the call and put option & by also taking a short position in the call and put option. 

Let us now cover long unwinding and short covering for both Call and Put options.

As there are different strike prices in an options contract, all the strike prices will have contracts unwinding, covering, and trading.

Long Unwinding In The Stock Market

Long Unwinding And Short Covering In Call Option

A call option is bought when the price of the underlying asset is expected to increase and a call option contract is written/sold when the seller is of the view that the price of the underlying asset is expected to decrease and he wants to pocket the premium.

A long unwinding in a call option happens when there is a decrease in the premium (Option price) of a particular strike price along with a decrease in open interest. This means that buyers who were bullish on the price of the underlying asset are exiting their positions.

A short covering in a call option happens when there is an increase in the premium of a particular strike price along with a decrease in open interest. This means that the sellers who were expecting the price of an underlying asset to rise are exiting the market.

Here is an example of long unwinding and short covering in call option in the form of a table

Let us assume a strike price of 17000 is trading at a premium of Rs 100 and has an open interest of 10000. The current market level is at 16900.

ScenariosStrike PricePremium% ChangeOpen InterestChange in OIunwinding/coveringMarket View
Current Level1700010010000–-
Case 11700090-10%8900-1100Long unwindingBearish
Case 217000110+10%9000-1000Short coveringBullish

Case 1: In this scenario, you can see that the price of the options contract has decreased along with the increase in the open interest. This indicates long unwinding taking place. This means the expectation of the market to increase from 16900 to 17000 and beyond is getting exhausted.

Case 2: In this scenario, you can notice that, while the price of the options contract has increased, there is a decrease in the open interest. This indicates a short covering taking place. This means, the expectations of the market going towards 17000 have increased and there is a bullish view in the market.

Long Unwinding And Short Covering In The Put Option

A put option is bought when the price of the underlying asset is expected to decrease and a put option contract is written/sold when the seller is of the view that the price of the underlying asset is likely to go up and wants to pocket the premium by selling the put option.

A long unwinding in put option means there is an expectation that the price of the underlying asset is likely to increase in the near future. This is indicated by the decrease in the premium of a particular strike price (Put option) along with the decrease in its open interest

Short covering in a put option happens when there is an increase in the premium of a particular strike price along with a decrease in open interest. This means that the buyers of the Put Option are exiting the market. This indicates a bearish sentiment building up in the market.

Here is an example of build-up in call option in the form of a table

Let us assume a strike price of 17000 which is trading at a current premium of Rs 100 and an open interest of 10000. The current market level is at 17100.

ScenariosStrike PricePremium% ChangeOpen InterestChange in OIBuild-upMarket View
Current Level1700010010000–-Neutral
Case 11700090-10%90001000Long unwindingBullish
Case 217000110+10%90001000Short coveringBearish

Case 1: In this scenario, you can see that the premium of the options contract has decreased along with the open interest. This indicates long unwinding (in the Put option) is taking place.

Case 2: In this scenario, you can notice that, while the price of the options contract has increased, there is a decrease in the open interest. This means, the expectations of the market to reach 17000 have increased and there is a bearish sentiment in the market.

Note: To determine the overall sentiment of the market, we must examine the unwinding and covering of all call and put option strike prices collectively.

Also Read: Short Build Up, Long Build Up Meaning, And Examples!

How Do You Know If You Have A Long Unwinding In A Stock And Short Covering An A Stock?

Simply put you can know if you have long unwinding in stock if its open interest is decreasing along with its price which means the current downtrend is weakening.

A Short Covering happens in a stock when the open interest is declining and the price of the stock is increasing. This means the current uptrend is declining in the market.

In Closing

In this article, we covered what is long unwinding in the stock market and also discussed short covering in cash, futures, and options markets.

Knowing when a trend is getting exhausted is very important in the stock market. It can help individuals exit the market at the right time and also help them take reversal bets in the market.

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