Brazilian hedge fund managers who correctly anticipated a strong first-round performance by right-wing presidential candidate Flávio Bolsonaro are adjusting their derivatives positions following a sharp rally in local markets, according to a report by Bloomberg.

They are also maintaining exposure ahead of the presidential runoff on 25 October.

Ace Capital, Vista Capital and Legacy Capital were among the strongest performers on Monday after Bolsonaro finished approximately two percentage points ahead of incumbent President Luiz Inácio Lula da Silva in the first round of voting. The result triggered a surge in Brazilian equities and the country's currency, the real, alongside a sharp decline in interest-rate swap contracts as investors priced in the possibility of lower borrowing costs.

Ace Capital founder Fabricio Taschetto has reduced options positions that expanded significantly in value during the rally, while Vista Capital's João Landau plans to make similar adjustments ahead of the runoff. Felipe Guerra, co-founder and chief investment officer of Legacy Capital, said the firm had made only marginal reductions to some positions, anticipating further gains across Brazilian assets.

Guerra said markets were assigning a 90% probability to Bolsonaro winning the presidency, with his Legacy Capital Alpha fund gaining 9.2% after fees on Monday, its strongest daily performance in eight years.

Vista Multiestrategia, Legacy Capital Alpha and Ace Capital were among the leading performers in Bloomberg's tracking of almost 200 hedge funds. Vista benefited from bullish positions in Brazilian equities, including call options on XP Inc. and Cosan, while Ace profited from derivatives linked to the iShares MSCI Brazil exchange-traded fund. Legacy entered the election positioned to benefit from gains across multiple asset classes.

Taschetto described the call options on the Brazil ETF as potentially the most asymmetric trade he had undertaken. The position was the largest contributor to Ace's performance on Monday, when the fund gained 6.8%. Although the firm has subsequently reduced its exposure, it remains positioned for further appreciation in Brazilian assets.

Brazilian hedge funds tracked by Bloomberg returned an average of 1.7% on Monday, compared with a 0.1% gain in the benchmark interbank deposit rate. The Ibovespa equity index rose 7.7%. A separate basket of Brazilian hedge funds monitored by the country's capital markets association advanced 2.1%, its strongest daily performance in more than six years.

Despite the rally, investors are continuing to hedge against the possibility of Lula recovering support before the second round. Significant purchases of put options and put spreads expiring before the end of October suggest some market participants are protecting against a reversal. Implied volatility has also declined, particularly for call options, indicating reduced willingness among traders to pay for exposure to further upside.

Brazilian assets have nevertheless continued to outperform global markets since Monday's surge. The benchmark equity index was on course for a weekly gain of 7.6%, while the currency had appreciated approximately 4% over the same period.