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Lokeshwarri S.K

Chennai, Aug. 23 An interesting shift is taking place in the trading pattern in the derivatives segment of the National Stock Exchange (NSE).

Volume in index options has increased sharply while the trading interest in the riskier stock futures is on the wane.

This implies that participants in the futures and options (F & O) segment are graduating to more complex derivative instruments that can minimise risk and lead to better capital preservation. It also signals higher participation by informed investors in F&O.

The share of index options in the traded value of the derivatives segment has increased from 12 per cent in February to 30 per cent in July, while the share of stock futures trading has declined from 46 per cent to 32 per cent.

Daily traded volume in index options touched an all-time high on July 23 this year.

The dominance of stock futures, both in terms of trading volumes and open interest, was one of the strange quirks of the Indian derivatives market. Index futures came second, with options a poor third.

This opposed trends in developed markets where options are preferred due to their lower risk and initial outlay.

The market crashes in May 2006 and again in January this year were prompted by large-scale unwinding in stock and index futures held by novice traders.

What has brought about this change?

Mr Sandeep Nayak, Senior Vice-President and Head - Private Client Group Dealings, Kotak Securities, points out that lower appetite for risk has triggered this shift.

“The vicious and abrupt collapse of the market in January and increased volatility thereafter had resulted in investors adopting a more cautious approach, with higher emphasis on limiting losses." "In contrast to trading the stock and index futures where risk is unlimited, a purchase of a call option where the premium cost is the maximum possible loss enhances the trader’s ability to withstand higher volatility without undue panic.”

Many of the novice traders who were more comfortable with the futures have exited the markets, badly singed in the first quarter of this year.

“The reduced presence of retail investors is clearly reflected in the lower cost of carry of futures (futures are trading at 60-70 bps higher than their underlying spot) as compared to late 2007/early 2008 when cost of carry was 100/120 bps”.

“The higher cost of carry was due to presence of retail investors who were doing leverage trading to make quick money,” says Mr Sandeep Singal, co-head, institutional derivatives business with Emkay Global Financial Services.

With portfolio hedging becoming an imperative in a protracted down trend, the long-dated options introduced six months ago, have been thriving of late.

“Currently, there is more than Rs 9,000 crore of open interest in options expiring on or after December 8. There are institutional investors active in these long-dated options", added Mr Naik.

Changes in the securities transaction tax on options in the Union Budget of 2008 is the other reason he attributes to the option trading seeing more action.

Traders are also forced to look at adopting more complex trading strategies including a mix of futures and options, arbitrage, time value stripping and so on to play the current non-trending market.

The fact that the National Stock Exchange has become the fourth largest exchange in the world in daily traded value in index options is a fall-out of this change in trading style among the Indian investors.

More Stories on : Derivatives Markets | Stock Markets

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