Foreign investors are loading up on options to hedge their equity portfolios against a slide in benchmark indexes as they worry that Prime Minister Narendra Modi's party may not achieve the landslide victory predicted by opinion polls just weeks ago.
The last major poll had estimated that the ruling Bharatiya Janata Party (BJP) party would win 342 seats, comfortably above the 272 majority required to return to power.
But a lower turnout so far in India's general elections and changing political rhetoric have dampened expectations of a landslide victory for the BJP and its allies.
Votes are set to be counted on June 4.
Foreign investors worried about the election outcome will resort to buying puts of the Nifty 50 or the Bank Nifty, which are the most liquid derivatives, said Vineet Arora, managing director at Dubai-based investment firm NAV Capital.
They may opt for derivatives on other indexes depending on their portfolio composition, he said.
Ahead of the results, the net open interest of put options on Indian indexes held by foreign investors hit the highest since at least January 2019, according to data complied by Reuters, based on information provided by the National Stock Exchange.
The net open interest - the difference between long put and short put positions - is currently at 2.5 times the daily year-to-date average.
The Nifty 50 Index last week fell 1.9%, compared to a 1.85% rally in U.S. equities and a 1% gain in the MSCI Emerging Markets Index.
On Tuesday, the Nifty 50 was up 0.1% at 22,130.20.
A put option is a derivative contract that investors turn to protect their equity portfolio from losses.
A buyer of a put option pays a premium and, in turn, earns the right to sell the underlying at a particular price, called the strike price.
A pick up in the open interest, an indicator used to determine the extent of wagers on the contracts, has coincided with increased foreign investor selling in the cash market.
Foreign investors took out $2 billion from Indian equities last week, having taken out $1.9 billion in April. They had bought $4.2 billion in March.
Volatility has risen with the Nifty volatility index at its highest in one-and-a-half years.
It is "quite possible" that foreign investors are looking at the price action on the Indian market and deciding to hedge, said Samir Arora, fund manager at Mumbai-based Helios Capital.
Buying puts is among the easiest way to hedge exposure, he added.
The highest open interest on puts is at 22,000 and 21,000 strike price for the monthly contract expiring on June 27. Open interest on weekly contracts is much lower due to limited volumes.
