MUMBAI: Foreign investors, drivers of domestic stocks, have increased their bearish bets by buying Nifty put options, raising fears of a further decline in markets despite the government having postponed a controversial set of tax laws, which has spooked them, by a year.
The government announcement that general anti-avoidance rules (GAAR) had been deferred to FY14 led to huge short-covering on Monday, which pulled the markets back from the brink and raised hopes that the bounce-back will continue.
However, Nifty shed over 100 points to settle just under the 5000-mark on Tuesday, underscoring the view that the economy’s bleaker prospects are a bigger concern for investors than GAAR.
“FIIs have been buying 4800-4900 Nifty index puts over the past two days to hedge their long books,” said TS Harihar, head – institutional derivatives, ICICI Securities. “Sentiment is still bearish what with the rupee at lows of 53-54 (to the US dollar) and May typically being a bad month for the markets.”
Apart from an increase in put open interest – the number of shares that have been added to puts of lower strike prices – the Nifty futures index on Tuesday moved into an almost 5-point discount at 4995 to the underlying index from a 11-point premium in the previous trading session. The discount was prompted by an addition of short sellers, which is borne out by an increase in Nifty futures OI by 17.44 lakh shares amid a 131-point fall in the index.
The put buying by FIIs and other investors who expect bearishness to continue has raised implied volatilities of puts to 24-25% – expectations of market swings on either side – from 17-18% a week ago when markets were stuck in a 5150-5400range. While calls at 5200 and 5400 also witnessed an addition of open interest, a low volatility at 18% indicates that these have been dominated by writers (sellers) than buyers.
“Those having large portfolios such as FIIs are buying puts on expectations of a further decline in markets but those not wanting to add to their portfolios under the current conditions are neither buying calls in a big way, all of which goes to show that the sentiment is bearish,” said Siddarth Bhamre, head-derivatives, Angel Broking.
“For me, this is a sell-on-rally market. The addition of short positions in index futures, which has moved into a discount, conforms with the market expectations of bearishness.” Hedgers who prefer to cover their portfolios by taking exposure to derivatives normally choose options over futures, which limit their losses to the premiums paid to buy a call or put. Futures, on the other hand, expose holders to unlimited losses and unlimited gains as they have to settle mark-to-market positions on a daily basis.