NEW YORK, Oct 2 (Reuters) - The prospect of leftist Dilma Rousseff winning another term as Brazil's president has caused investors to flee Brazilian markets, but bets in the U.S. options market suggest the selling may have run its course.
Citizens in Latin America's largest economy will vote on Sunday, with polls showing Rousseff solidifying her lead over opposition candidate Marina Silva, who is looking to put an end to 12 years of Workers' Party rule.
In recent weeks, the ups and downs in the heavily-traded Brazil iShares ETF, oil giant Petrobras, and other top Brazilian companies listed in the United States have been driven more by presidential polls than company fundamentals.
That's turned that market into a wild place. The iShares MSCI Brazil index fund has plunged about 21 percent since the beginning of September and volatility has risen sharply as the election approaches.
The market rallied in August when Silva, an environmentalist with pro-market credentials, entered the race and surged in the polls, leapfrogging centrist candidate Aecio Neves, as she found support from voters dissatisfied with the weak economy and Rousseff's policies.
Since then, Rousseff has regained the lead. As the market has dropped, though, the volume of call options - generally used for bullish bets - have risen. Growth in outstanding calls on the iShares MSCI Brazil ETF in September outpaced the growth in put activity.
"This drop is definitely overdone. Nothing has changed fundamentally that would justify this kind of move," said Charles Sizemore, chief investment officer at Sizemore Capital Management, a Dallas-based investment firm, which owns the EWZ ETF.
In September, call volume outpaced put volume in the EWZ, with about 1.677 million calls versus 1.672 million puts. By comparison, July and August showed an average of 950,700 puts and just 816,000 calls, according to Trade Alert data.
Adam Perlaky, chief strategist at New York-based broker New Albion Partners LLC linked the selloff to the weakening Brazillian real and said a Rousseff win would probably be negatively perceived by the market, but given the recent sell-off much of it could have already been factored into market expectations.
The Brazilian real had its worst month in three years in September, losing nearly 9 percent and underperforming its regional peers as polls showed greater chances of Rousseff winning re-election.
The unknown is keeping investors on their toes. The CBOE Brazil ETF volatility Index rose to a new high this week since its inception in February 2012.
Meanwhile, the cost of a straddle - where an investor buys an at-the-money put option and similar call option, in a bet on volatility - suggest a move of about 6 percent in Brazil's market by the end of next week, the clearest sign investors expect post-election gyrations in stocks.
"I bought EWZ on Tuesday and will continue to add to the position as we drop, or perhaps sell upside calls to generate additional income until folks realize the plunge was overdone," said Mark Mansfield, an independent investor in Dallas, Texas, referring to a strategy that caps an investor's upside while still collecting a premium for selling those calls.
The ETF is not the only issue seeing a rush of activity in the options market. Brazil's top companies have also seen a flurry of options activity.
The country's two largest private sector banks Itau Unibanco Holding SA , Banco Bradesco SA , iron ore miner Vale SA and oil company Petroleo Brasileiro, or Petrobras , have all seen options volumes on their U.S.-listed shares swell.
The combined options volume in September for Petrobras, Vale, Itau and Banco Bradesco, spiked to 4.60 million contracts, about double July and August's average monthly volume of 2.33 million, according to Trade Alert.
Implied volatility, a measure of the risk that big moves in a stock pose, has climbed sharply over September for Petrobras, Banco Bradesco and Itau, with all three showing 30-day implied volatility at 52-week highs, according to options analytics firm Livevol Inc. (Reporting by Saqib Iqbal Ahmed; Editing by David Gaffen and Andrew Hay)