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Foreign portfolio investors (FPIs) have nearly doubled their protection against a potential Indian market crash as the two-week-old Iran war fuels risk-off sentiment.

Cumulative net short positions held by FPIs in index futures such as Nifty and Bank Nifty rose to 226,327 contracts on Thursday, up from 124,368 on 27 February, a day before hostilities began, according to exchange data. That means FPIs have added 101,959 more short contracts, costing about ₹19,974.9 crore in two weeks, according to NSE data.

The short position is close to the record high of 231,796 contracts seen on 24 February last year, when markets were roiled by proposed Trump tariffs, per data from analytical firm IndiaCharts.

"These are hedges taken by large funds that tend to be buyers of EMs (emerging markets) like India," said U.R. Bhat, founder of investment platform Alphaniti Fintech. "The significant rise in hedging reflects concerns over the fallout from a protracted war with neither side (US/Israel versus Iran) taking any conciliatory steps thus far."

Bhat said these long-term investors typically hedge their portfolios during volatility rather than selling shares in the secondary market at higher transaction costs.

"Rather than selling and then buying again in cash, it's cheaper for them to short index futures and square them off once the crisis shows signs of blowing over," added Bhat.

These hedges offset declines in portfolio value. If an investor holds Nifty 50 stocks and the index corrects by 10%, futures prices also decline by a similar extent, helping compensate for unrealised losses in the cash portfolio.

On the other hand, if the index rises in the event of abating West Asia tensions, the fall in the short futures positions are offset by gains in the index-based cash stocks.

"Hedging is a risk mitigation strategy adopted by large institutional investors during a risk-off event like the one we are in, where no side involved in the war is taking steps for a rapprochement, at least for now," said S.K. Joshi, consultant at Khambatta Securities.

Joshi explained that the rise in hedging activity by FPIs signifies the risk of higher crude prices for an economy like India that imports nearly 90% of its crude requirement of 5.5 million barrels a day, of which roughly half comes through the Strait of Hormuz.

Brent crude has surged 39% since the conflict began to $100.46 a barrel, raising fears of inflationary pressures.

Investor fear is palpable. The Nifty fell 6.1% since the start of the war to to 23639.15 on Thursday, against a 4.7% fall in the Dow Jones and a half percent rise in Israel's benchmark TA-125 despite these two countries being Iran's main adversaries.

Bhat said he would "not be surprised" if the Nifty tests its 52-week low of 21743.65 hit on 7 April if the war escalates. The 52-week low came on the eve of President Trump announcing reciprocal tariff against the US' trade partners.

The Nifty had risen 21% from 21743.65 on 7 April to a record high of 26372.2 on 5 January this year. Since then, however, rising global economic and geopolitical uncertainties have resulted in Nifty correcting 10.4% through Thursday.

Alongside the hedging activity by long-only funds, foreign hedge funds and high-frequency traders, who take tactical bets have sold ₹47,144.61 crore worth of shares in the cash market over the past two weeks, according to depository data.

Though this selling was absorbed by domestic institutional investor purchases of ₹72,892 crore over the same period, the exit to FPIs was given at lower prices, resulting in the 6.1% fall in Nifty since the war started.

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