Nifty, Sensex futures: Weak footing

Anup Menon

M.S. Narasimhan

AFTER debating for more than five years the desirability of introducing derivative products, the Securities and Exchange Board of India (SEBI) allowed derivatives trading to start in the form of stock index futures.

These commenced trading in June 2000.

A year down the line, in July 2001, SEBI permitted trading to commence on index options and individual stock options. Market interest in index futures has picked up slowly over the last year (see Table 1). However, the growth in volumes, as can be seen, is small.

Click here for Table

Initially, it was felt that the presence of badla trading and the restrictions on FIIs and mutual funds in buying index futures were instrumental for the lack of interest in the index futures market. Over the year, many of these problems were remedied. But the market is still not showing any signs of improvement.

Well tracked, thinly traded

To understand the lack of interest in futures, we first need to know about the underlying security which, in this case, happens to be the index. The index is a portfolio of stocks, and a buyer of index futures invests in a portfolio of stocks without actually buying into the individual components of the index.

Two index futures products are available to Indian investors. The Sensex, which is the benchmark index of the Bombay Stock Exchange, consists of 30 stocks; and the Nifty, the benchmark index of the National Stock Exchange, consists of 50 stocks.

Given that the stocks which form part of the indices are some of the biggest and most profitable companies in the country, they are also the most actively traded in the spot market.

But, in the futures market, the picture is different. A buyer of index futures is expected to pay only a margin and is thus also the seller to buy or short-sell a portfolio of assets. Trading in index futures thus automatically provides a leverage (or the facility of borrowing) to traders.

Therefore, when ALBM/BLISS and badla facilities were withdrawn in June 2001, traders and speculators should have naturally moved to the index futures market, which provides both the facilities of borrowing funds and a portfolio of stocks. But this has not happened.

Stocks yes, index no

A positive reaction of the market to the proposal of individual stocks futures shows investors' preference for individual stocks to portfolios of stocks. What could be the reason?

The answer to this question could be quite straightforward. For even in the index, not all companies are as actively traded as their peers. For instance, stocks such as Kochi Refineries and Oriental Bank of Commerce, which form part of the Nifty, are not sought after stocks by individual investors or funds.

Click here for Table

The volume of trading in index stocks is highly skewed (see table). For example, against Satyam's volume of Rs 87,312 crore during between June 12, 2000 and July 31, 2001, there were 12 stocks whose volume of turnover during the same period was less than Rs 500 crore.