Foreign portfolio investors (FPIs) have raised their net short exposure on index futures in Wednesday’s rollover to 2.97 lakh contracts, a multi-year high.

Until Wednesday, FPIs were 50 per cent long in index futures, which dipped to 13 per cent on Thursday, resulting in one of the largest net short positions being created overnight. This indicates that the overseas investors are playing on the bearish side of the market ahead of election results, which are due on June 4.

The formation of bearish bets does not necessarily mean that the market will fall in the coming days. In October last year, for instance, the long-short ratio had dipped to 11 per cent. In November, however, FPIs started covering their net shorts and a 1,000- point rally followed, that took Nifty to 20,000.

“A similar short covering may happen this time, too, especially if the event (election results) is in the market’s favour,” said Soni Patnaik, AVP - Derivative Research, JM Financial Services.

This time, though, not all parameters are in the oversold zone. Which is why FPIs may hold on or even increase their shorts if the event outcome is not favourable. Or they may book profits in the shorts - for which the markets will have to crash, said Patnaik.

Hedging operations

“While this large position may raise concerns, it is also possible that FPIs are engaging in normal hedging operations. Similar high exposure levels were observed at the beginning of May, which were subsequently reduced within 3-4 trading days. Given the potential for market swings, it is advisable to maintain comprehensive hedges during such pivotal events,” said a note by Nuvama Wealth and Investment.

Net client stock futures open interest is at 1.962 million contracts, a multi-year high, signaling that individual investors are significantly leveraged. “In such a state, any negative developments could lead to substantial market volatility and retail investors might be forced to unwind positions rapidly, exacerbating market declines,” the Nuvama note added.

Spike in options

The increasing volatility has also resulted in a spike in options premium in the past few days. The Nifty VIX has risen 83 per cent to 24.6 in the last one month.

“We are seeing a lot of deep out-of-the-money (OTM) options writing because premiums are expensive,” said Patnaik.

For example, deep OTM options such as 24000 CE are trading at an expensive premium of Rs 40-50. This is giving ample opportunities for options writers to implement their strategies given that the volatility index is expected to cool off once the results are declared, which will result in a fall in options premiums, Patnaik said.

Nifty formed a long-legged Doji on May 31 and breached the 5-day losing streak. In the last week, the Nifty shed 1.85 per cent, with the IT index down 4 per cent and Oil & Gas losing 3.78 per cent.

“Nifty could see volatile moves early next week based on the outcome of exit polls and later the actual results of voting. Nifty could stay in the 22150-22794 band for the early part of next week,” said Deepak Jasani - Head Retail Research, HDFC Securities.