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Derivatives: More options

Dec 19, 2000

It’s been about half a year since derivatives have been trading on the both the exchanges (NSE and BSE). Initially only three contracts have been introduced by both the exchanges. The financial community has been watching the derivatives markets very keenly. World over the derivative markets are bigger than the equity markets. The interest has grown gradually. Initially, the volumes were just 100 contracts but for the last month the volumes traded are in the region of 1000 contracts. As of now both, BSE and NSE, have introduced a three tier margining method. This includes, initial margins, mark to market margin and spread margins. Additionally, there is a provision for ad-hock margins that can be introduced as and when required. According to the J. R Verma committee report the initial margin has been pegged around 10%. This can be paid in terms of collateral. The mark to market settlement is only cash based.

Spread margin computations involve contracts that are basically opposite in nature (long and short) but have expiry in different months. A spread implies a long and a short obligation with the exchange. Therefore, the default risk is lower; hence, the margins are a fraction of one of the contracts instead of being on both the contracts.

Suppose there are two contracts one for January and one for February. If both the contracts are long then the initial margin will be 2*X (X is the margin on a contract) but if one of them were to be short then the initial margin would be a*X (where a is between 0 and 0.99 i.e. lower than the margin on one side).

As of now the margins are flat across the board but as the markets mature, margining will get more subjective. It will see the introduction of more advanced margining methods like SPAN (standard portfolio analysis) margining.

But so far, of what has been seen, the major players in the derivative markets have been the financial institutions and the retail investor is yet to come in. This is due to the slightly complex nature of the derivative instruments. According to a study conducted it is estimated that the use of derivatives in the US markets is roughly split in the ratio of 60:40 between institutions and individual investors.

Then
22th June, 2000

BSE (SENSEX CLOSE: 4,794.1)
Series Previous
close
Day’s
high
Day’s
low
Closing
price
Volume
(no. of contracts)
Value
(Rs in m)
No. of
trades
Open interest
(no. of contracts)
June 4,811.10 4,790 4,691 4,749 97 23 58 139
July 4,865.50 4,839 4,720 4,787.5 6 1.4 6 14
Aug 4,920.10 4,880 4,880 4,880 1 0.2 1 3
Total         104 24.7 65 156

NSE (NIFTY CLOSE : 1,490.1)
Series Previous
close
Day’s
high
Day’s
low
Closing
price
Volume
(no. of contracts)
Value
(Rs in m)
No. of
trades
Open interest
(no. of contracts)
June 1,486 1,499 1,474 1,493 8,000 11.8 32 16,200
July 1,503 1,500 1,491 1,500 1,000 1.4 5 4,000
August 1,502 - - - - - - -
Total         9,000 13.3 37 20,200

Now
15th December, 2000

BSE (SENSEX CLOSE: 4,137.1)
Series Day’s
high
Day’s
low
Last traded
price
Volume
(no. of contracts)
Value
(Rs in m)
No. of
trades
Open interest
(no. of contracts)
Dec 4,259 4,139 4,145 756 158 193 1,096
Jan 4,250 4,156 4,156 62 13 18 87
Feb 4,250 4,250 4,250 5 1 1 15
Total       823 172 212 1,198

NSE (NIFTY CLOSE : 1,311.1)
Series Day’s
high
Day’s
low
Last traded
price
Volume
(no. of contracts)
Value
(Rs in m)
No. of
trades
Open interest
(no. of contracts)
Dec 1,345 1,311 1,312 441 116 206 1,599
Jan 1,337 1,315 1,323 89 24 32 160
Feb 1,345 1,322 1,322 7 2 7 12
Total       537 141 245 1,771

BSE is putting in a lot of effort to popularise the derivatives market and generate awareness amongst the investing community. It is considering increasing trading hours for the derivatives segment, which is already half an hour more than the equities market. Also, it will be introducing new products like index options and stock options sometime next year.

These are steps that will help the Indian capital markets mature. Today the investors can quantify the down side thanks to derivatives. At this time with the limited experience in the area hedging would be a smarter choice. Speculation is something, which the retail segment should look at with a lot of caution. But one thing is for sure the onus is on the individual investor too. The maturity of the capital markets is not the sole responsibility of the governing bodies and exchanges.

To know more about different derivatives product and their uses please refer to our four part Part I, Part II, Part III and Part IV special report.


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