HNIs losing on option bets, but soaring premium a big draw

MUMBAI: Ultra-rich investors have emerged as counterparties to foreign investors in trades that could potentially backfire on them if volatility spikes from current highs.

Lured by option prices trading at sixteen-month highs and the empirical fact that option sellers make money 7 out of 10 times, these investors are aggressively selling (or writing) index put options, said derivatives analysts. A buyer of a call option bets the markets will rise, while a buyer of a put option bets the market will fall and seeks to hedge her underlying portfolio. The seller collects premiums, price for selling options, from the buyer.

As India Vix, a measure of traders’ expectations of near-term volatility, spiked to a 16-month closing high of 28.71 on Tuesday and the Nifty tanked over 2 per cent to 7,786, the provisional price of the 7800 put option, expiring on September 24, jumped 80 per cent to Rs 230, while the 7700 option jumped 88 per cent to Rs 190.8, Bloomberg data showed. The rise in prices of these strikes is accompanied by a jump in outstanding traders’ interest, or open interest, which shows high buy-sell activity. The fact that retail clients are heavy sellers of put options on Nifty is borne out by NSE data on open interest for clients and FIIs.

On Monday, while FIIs net purchased 10.23 lakh index puts contracts (mostly Nifty), clients, comprising HNIs, had net sold 8.3 lakh puts. “These kind of option prices have been seen but once or twice over the past two years,” said Bhavin Desai, derivatives analyst at Motilal Oswal Financial Services. “It’s really greed that’s driving HNI and ultra-HNI clients to playing these risky trades, as a majority of the time options (for buyers) end out-of-the-money.”

The same scenario panned out when Nifty fell by its steepest in six years on August 24. In the trading session prior to that day, FIIs were net long index puts at 10.97 lakh contracts. Clients were net short or sellers of 9.31 lakh puts. A day later, when put option prices spiked by over 1000 per cent, FIIs raised their positions to 11.23 lakh contracts, while clients trimmed theirs a bit to 9.2 lakh outstanding short contracts.

Hemant Nahata, head of derivatives at India Infoline, agreed that high option prices are a big draw for rich investors. He said that these clients were hedging their bearish put option positions by mounting bearish bets on Nifty futures. This helps in the event of Nifty falling since the rise in put option prices will be offset to an extent by the gains made on shorting index futures.

Nahata’s claim is borne by NSE data which shows that on Monday clients had net sold 3.7 lakh index futures – mostly Nifty. This suggests that for every 100 puts clients are selling, they are shorting around 45 Nifty futures. The risk, according to SK Joshi, head of wealth management at Khambatta Securities, is that an unforeseen rise in volatility could sharply push up option prices leaving clients little time to short index futures.