Put sellers lose big as market crashes again

By Ram Sahgal and Jaikishan Yadav

MUMBAI: Rich investors who sold put options to foreign institutional investors (FIIs) believing that the recent bounce in the markets was here to stay have been left licking their wounds. The stock market fall on Tuesday has resulted in the prices of these options more than doubling, forcing the sellers to square off at a loss as the Nifty once again settled below its 200-day moving average (DMA) of 8,289.

Successive FII buying of Nifty puts – bets the index would fall – in turn pushed India’s Volatility Index (VIX), a measure of traders’ near-term expectations of volatility or market swings, up more than 10% to a seven-week high of 20.55 on Tuesday. The loss for the well-heeled traders was particularly precipitous in the 8300, 8200 and the 8100 strike put options, with prices more than doubling from Monday’s close, forcing them to square off a fair bit of their positions.

"Investors who sold puts are staring at huge notional losses and some have even cut positions to avoid further pain," said Bhavin Desai, derivatives analyst with Motilal Oswal. "The rise in option IVs (implied volatility) clearly is a disturbing sign as it foretells a continued correction." Implied volatility is a key aspect of the pricing of options; rise or fall in IV leads to changes in option’s premium or value.

As a reaction to the carnage on Tuesday, option sellers also began unwinding positions in the 8100 and 8000 strike puts amid fears volatility would rise and the correction continue. The Nifty 8300 put saw a decline in outstanding trader positions by a fifth as its volatility and price rose.

Maximum outstanding positions have been built at 8000, which forms a crucial support level, according to derivatives analysts. Siddharth Bhamre, who heads derivatives at Angel Broking, said the sheer rise in put buying and unwinding of bullish bets in index futures by foreign investors over the past few sessions indicated the "transient" nature of the bounce on Friday and Monday.

From the beginning of the present series of derivatives, data show clients have been net selling put options. The number of contracts net sold was 675, 790 on Monday, a day before Tuesday’s fall. FIIs, on the other hand, have successively been buying put options. FIIs’ net purchases of puts have risen to a staggering 901,797 contracts, from 768,933 a week ago.

What experts like SK Joshi, head of wealth management at Khambatta Securities, find particularly disconcerting is that along with their buying of Nifty put options and unwinding in the cash market, FIIs have also been chopping their bullish positions in Nifty futures.

"So far we have seen unwinding of bullish bets in futures. I fear if the situation persists, it wouldn’t be far off when FIIs start building bearish bets in Nifty futures as well," said Joshi. "That would be really bad news, if it happens."