Investors take cover ahead of election outcome

A put option buyer typically anticipates a market decline, whereas a call option buyer expects the market to rise. Option buyers pay a premium to either buy or sell the index at a future date, as the actual index cannot be delivered.(Image: Pixabay)
A put option buyer typically anticipates a market decline, whereas a call option buyer expects the market to rise. Option buyers pay a premium to either buy or sell the index at a future date, as the actual index cannot be delivered.(Image: Pixabay)

Summary

  • Investors are concerned about a potential market correction if the ruling coalition's victory margin is lower than expected

Mumbai: Investors are increasingly seeking protection for their stock portfolios ahead of the Lok Sabha election result on 4 June, due to concerns about a potential market correction if the ruling coalition's victory margin is lower than expected.

This trend is evident from the surge in outstanding contracts for the 30 May Nifty options. As of Monday, there were about 1.48 million outstanding put contracts (each contract comprises 25 shares), compared to 1.16 million call contracts, reflecting increased market caution.

A put option buyer typically anticipates a market decline, whereas a call option buyer expects the market to rise. Option buyers pay a premium to either buy or sell the index at a future date to the option sellers. The differences in index values are exchanged for cash as the index cannot be delivered.

"More outstanding puts than calls suggest a degree of nervousness," said Chandan Taparia SVP ( derivatives & technicals), Motilal Oswal Financial Services. He said the market has factored in an NDA victory, but in case the incumbent wins less than 400 seats, profit booking could ensue.

"The worst case outcome is 1,000-1,500 point dip on Nifty, but the dip will be bought on the premise of political continuity and economic stability. So, it's a buy-on-dips market," he added.

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The rise in uncertainty is captured by fear gauge India Vix, which rose 39% to a one-year high of 16.96 in the week to Monday. When Vix rises markets tend to correct, and vice versa. The index is computed on call and put option bid-ask spreads.

NSE, the country's biggest stock exchange, offers index options on Nifty, Bank Nifty and Nifty Financial Services. These are the most liquid, accounting for 98% of total derivatives turnover on the exchange.

With the Lok Sabha election result slated for 4 June, the position build-up in the equity markets is seen on options expiring on 30 May. This also gives the impression that the market could witness a pullback ahead of the results and then recover post the result if the NDA returns to power.

"The adage of 'sell in May and go away ' seems like it could materialise this time around," said A. Balasubramanian, managing director and chief executive, Aditya Birla Sun Life AMC. "The past few years have not seen this effect, but just because of the event before us we might see it happen before rather than after the same, when we expect buoyancy to resume."

Kruti Shah, quant analyst, at Equirus, expects the market to trade in 21700-22800 range through the election outcome date.

"The Vix is rising and put buying has started by those desiring to protect their portfolios ahead of the event," Shah said. "But, so long as the crucial 21700 level is protected we don't see any problem. Any dip is a buying opportunity."

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Meanwhile, the Nifty traded near a record high of 22794.7 as of 3 May but closed at 22442.7 on Monday, which is just 1.5% below the peak.

If the market rises, losses on puts will be partially offset by gains in the stock portfolio. If it declines the losses will be offset by the rise in the put option price.

Typically, the weekly expiry sees the most activity, while the monthly expiry tends to be less liquid until the approach of that week. The expiries are slated for 9 May, 16 May, 23 May and 30 May. Currently, 9 May is the most liquid followed by 30 May because of the June 4 election results.

Also Read: Will investing in bonds be made easier in India?

 

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