The Hindu Business Line : High open interest in index put option deals

BL Research Bureau Indian stock markets had to climb a wall of scepticism in March. It is perhaps because of this lack of conviction that the short positions in index options have burgeoned to an all-time high this month.

According to data compiled by Bloomberg, total contracts outstanding in index-put options on March 20 was 15,43,665. That is a record high.

To put the figure in perspective, put option contracts outstanding at the end of February 2009 was 8,49,145 and at the end of January there were 5,89,762 contracts. If we consider the index put contracts outstanding at the end of December 2007, it was much lower at 1,90,163.

Put options are options that give the owner the right but not the obligation to sell a specified underlying at a specified date. Buyers of put options typically expect the price of the underlying stock or index to move lower. The open interest represents the number of contracts that are still outstanding at the end of a trading day.

Interestingly, data disseminated by SEBI on its Web site reveals that FIIs have increased their activity in the index options in March this year. Open interest in index options held by FIIs as on March 20 was 17,66,795 contracts.

Though we do not have details regarding the proportion of call and put options in this data, the overall open interest in index options held by FIIs is again at an all-time high. This figure is approximately 70 per cent higher than the outstanding index options held by FIIs at the end of February 2009.

Put options reaching a record high gains significance in the light of the sharp rally of almost 5 per cent witnessed in the Nifty on Monday.

Dow the reason?

Put options can be bought either for portfolio hedging or as a trading position in anticipation of future decline in stock prices. Since the Dow was plumbing a 12-year low in late February and the Nikkei was trading at 27-year low, many of the foreign investors could have initiated short positions by purchasing index put options in the last week of February and the first week of March expecting the Indian markets to follow the other equity markets lower.

However, the sharp reversal since March 6 would have put such traders in a tight corner leading to frantic squaring of such positions causing sharp up-moves akin to that witnessed on Monday.

It is also worth noting that there is a sharp decline in the open interest in the stock futures in March. The contracts outstanding in this segment on March 20 were 5,93,482, much lower than 12,41,915 contracts outstanding a month earlier. Stock futures are typically used by the domestic traders. Reduction in the open interest in stock futures indicates that local traders have reduced their activity in the markets.

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