Foreign investors taking large bets on expected rate hike by US Federal Reserve

By Ram Sahgal & Rathina Sabhapaty

Foreign investors are taking large bets on a likely market fall in September. They have begun buying significant number of put options based on Nifty in that month on fears of the US Federal Reserve raising interest rates for the first time in nine years. If the market falls in line with their fears, the rise in the value of the put options offsets to some extent the loss in value to their Nifty shares.

"The crises in China and Greece having been deferred temporarily, with China putting a bar on sale of listed company stocks by certain investors, FIIs have stepped up purchases of protection against another big event -a possible hike in the US interest rate when the Federal Reserve meets in September," said UR Bhat, director of FII advisory Dalton Capital Advisors.

FIIs (foreign institutional investors), which have cumulative investment of more than Rs 8 lakh crore in Indian shares, purchase cheap protection through put options based on Nifty or Bank Nifty. If the markets fall, the price of these options rise, offsetting (to an extent) the erosion in value of the Nifty and Bank Nifty basket shares held by FIIs.


On July 10, the net outstanding number of index put options (buy sell) held by FIIs were 9.8 lakh contracts, second only to the highest ever net holding a month ago.

Interestingly, the significant put buying over the past few days July 8-10 has been happening in the September series of options rather than in the existing series (July) or August. The buying over the two days encompassed put options from 8400-7800 levels.

The most active put option in the September series is the 8000 strike put option, in which outstanding positions stand at 28.36 lakh shares. Another active strike in September is the 7800 strike put with 10.3 lakh shares outstanding.The price of the 7800 strike put was . 57 on Friday Rs If the market falls from Friday's level of 8360.55 to below 7800 (or 7 per cent) by expiry of the September series on September 24, the value of the FIIs cash Nifty portfolio will fall by the same percentage. However, the value of the put option will also rise, offsetting the fall in the Nifty to a great extent.

"The accretion of puts is happening in the September series, which is when the Federal Open Markets Committee meets to announce its take on interest rate, state of the US economy, etc," said Hemant Nahata, senior derivatives analyst, India Infoline."This means there's a real fear of the US raising interest rates."

A hike in the US interest rate would strengthen the dollar against the rupee and reduce the dollar returns of the Nifty . Some FIIs could sell parts of their portfolio to limit the loss, while others will square off their put options at a profit.