FIIs likely to keep an eye on lows even as markets chase the highs

MUMBAI: In a move that signals their cautious approach despite record market highs foreign investors would continue buying Nifty put options to protect against a possible erosion in cash market portfolio if the market falls, said derivative analysts.

FIIs, the mainstay of the stock market, net sold equity worth Rs 964 crore in December and Rs 1,792 crore in the current month through Monday, except for the last few sessions after RBI cut a key rate at which it lends to banks last Thursday, ETIG Database shows.
However, they covered these share purchases after the rate cut by significant buying of Nifty at-the-money put options -whose strike or exercise price is closer to the underlying index level.

This works as follows. FI Is buy stocks when Nifty is at 8,500. They simultane ously purchase Nifty put options giving them a right to sell the index at that level in case it falls. If Nifty falls to 8,400, the value of their cash portfolios falls. But this fall is mitigated by a rise in the value of the Nifty put options.

The purchase of put op tions could continue in the run-up to the Budget so long as the market remains above the average level of 8,350, at which much of the selling since last month has happened, says Manoj Vayalar, senior derivative analyst at Religare. It will also result in an increase in volatility even if the market rises.

The Vix, which measures traders' perception of risk, has jumped 25 per cent from 13.80 at the beginning of the month to 17.27 on Tuesday, despite the market's rise in this period.

Normally, Vix rises when markets fall. This anomaly indicates heavy investments in index puts by FIIs to protect their cash market portfolios. However, SK Joshi, head of wealth management at Khambatta Securities said even if the market dips but holds above 8350 -the Nifty's average value at which they sold much of last month -the FIIs could use the profits gained from the puts to buy on dips.

Going by Monday's data, FIIs were net long on calls and massively long on index puts. However, in stock and index futures they were net short.

Derivative experts like Siddharth Bhamre of Angel Broking believes that FIIs have gained at the cost of retail and HNI clients, many of whom had sold index futures and both index call and put options on Monday.