To address the limitations first, contesting is seemingly limited to two seats. According to the Representation of the People Act, passed in 1951, and amended various times:
Notwithstanding anything contained in sub-section (6) or in any other
provisions of this Act, a person shall not be nominated as a candidate
for election (a) in the case of a general election to the House of the
People (whether or not held simultaneously from all Parliamentary
constituencies), from more than two Parliamentary constituencies;
As you say, if they win both elections they can only hold one seat, or potentially none, if they don't follow the proper procedure. From the same source:
Election to more than one seat in either House of Parliament or in the
House or either House of the legislature of a State. —If a person is
elected to more than one seat in either House of Parliament or in the
House or either House of the Legislature of a State, then, unless
within the prescribed time he resigns all but one of the seats [by
writing under his hand addressed to the Speaker or Chairman, as the
case may be, or to such other authority or officer as may be
prescribed], all the seats shall become vacant.
As for why this law exists, some commentators have suggested that the purpose of the law is as an electoral strategy, to allow parties to increase turnout:
Aditya Mukherjee, professor of contemporary history at New Delhi's
Jawaharlal Nehru University, suggested that allowing candidates to
contest from two constituencies sometimes helped political parties to
“mobilize voters” and “shore up their party’s prestige” during
“It is not unusual for politicians to contest from two seats in order
to have a multiplier effect on other constituencies,” Mr. Mukherjee
said. “This will attract more people to vote.”
Others say that the law exists to give politicians a backup plan to minimize their chances of losing re-election:
Now the question is, why is it that candidates contest from two
constituencies? One reason might be that they are unsure about one
seat and to book a place in parliament, they contest from another seat
of which they are confident. So one seat is undoubtedly safe to fall
back upon, if they lose the unsure one, and if the fortune smiles upon
them, they may even win both of them. You can call it a back-up plan.
This writer agrees that it's simply there to let politicians take a risk on one seat while not actually risking anything:
He is right. The provision exists not to a create a more robust and
diverse democracy but for the convenience of the politicians. It is
their back-up strategy at the expense of the people. It hardly
displays any commitment of the candidate towards the electorate he is
claiming to so want to serve.
Overall, it seems likely that the purpose of allowing politicians to contest from multiple places is to provide a safe backup option for them to expand their political power by getting a coveted seat, while not risking their current position.
However, it seems that in reality the language mentioned above was not included to increase the number of seats that politicians could contest from, but rather to limit it. This was due to an amendment made in 1996; the text of the amendment is here. Previously, politicians could contest from more than two seats:
The rule of limiting the candidate to contesting from a maximum of two
seats was introduced in 1996 through an amendment to the
Representation of the People Act (RP Act) of 1951. Before this law,
leaders were allowed to contest from as many seats as they could.
Biju Patnaik, the veteran leader from Odisha, earned the dubious
distinction of contesting the most number of seats simultaneously,
running for four assembly seats and one Lok Sabha seat in 1971.
Possibly two seats was a compromise between politicians who wanted to be able to run in an unlimited number of constituencies (probably those with political chances) and those who wanted to cut it all the way down to one seat.