Options contracts see a rise in activity ahead of 2019 Lok Sabha polls

Market participants have begun taking positions in the derivatives market to protect their portfolios from any adverse election outcome. Options contracts expiring in June 2019 are seeing a rise in activity as investors look to hedge their positions in case stocks slide after the results.

Activity is maximum in put options at a strike price of 9,000 and 10,500 on the Nifty50. Put options at both these levels are out-of-the-money, which means they would be profitable only if the benchmark Nifty50 falls significantly from its Friday’s close of 10,859.90.

A put option gives the buyer the right, but not the obligation, to sell at a pre-decided price. 

In effect, it allows the option buyer to lock in his selling price and profit in case the price falls. Investors hedge their existing long positions by buying such put options.

Call options allow one to lock in a buy price. The call options with the maximum activity are deep in-the-money at 5,000 levels on the Nifty. Traders remember two days of election results when the markets had seen huge volatility, enough to stop trading. In 2004, when the ruling National Democratic Alliance (NDA) lost the elections unexpectedly, the market had to stop trading briefly amid extreme volatility and the Sensex fell 11 per cent that day. 

A similar scene played out when the United Progressive Alliance came back to power in 2009 on hopes of a reforms push. This time, the market gained 17 per cent in a single day.

The markets also gained following the NDA’s victory in 2014. It rose 6.15 per cent over the previous close on an intra-day basis when the election results were declared on May 16. It ended the day with 0.9 per cent gains on profit-booking.

Options contracts trading six months forward are also unusual for the Indian derivatives market. Chandan Taparia, derivatives and technical analyst at Motilal Oswal Financial Services, said: “Typically there is action in contracts expiring within one to three months. Activity in long-dated derivatives options are seen to a lesser extent.” 

Vikas Jain, senior research analyst, Reliance Securities, said: “The open interest build-up in the derivatives segment is the outcome of some people wanting to hedge their portfolios ahead of the elections.”

Besides the elections, a negative global growth outlook is making people seek protection or hedge portfolios through long-dated options.

“The last couple of series have seen markets ending with huge volatility and that is why participants want to hedge their positions by looking all the major triggers including volatility in equity, crude oil, and currency and the upcoming quarterly results,” Taparia said. Experts say activity in derivatives could see an increase as the Lok Sabha elections come nearer.

“Activity could rise after the Budget and after April 2019 as the elections draw near,” Taparia said.

Activity at very low levels of a strike price of 5,000 points on the Nifty 50 is likely to be on account of structured products, say experts. These are mostly designed to help investors benefit from major market moves or downside protection.

The hedging comes even as the outlook seems bullish in the run-up to the elections. “If this bullish trend extends further then an all-time high can’t be ruled out before the general elections,” said Hadrien Mendonca, senior technical analyst at broking house IIFL.

Foreign brokerage house UBS Securities India in its equity strategy report suggested investors currently appeared to be pricing in a win for the ruling Bharatiya Janata Party.

“Our interactions with investors (especially overseas ones) and valuation multiples suggest BJP coming back in 2019 …. With today’s outcome, we expect the market focus to shift towards the upcoming general election in a more granular way, including evaluating various outcome possibilities,” said the report, authored by analyst Gautam Chhaochharia and economist Tanvee Gupta Jain on December 12, a day after the election results of five states were declared. 

SEEKING SAFETY 

• Long-dated options are seldom active
• But June 2019 options have seen a build-up
• Put options around Nifty 9,000 and 10,500 have seen most activity
• Investors wish to hedge election outcome, despite bullish outlook  
• More buying likely after interim Budget and as elections approach