SEARCH

No reason to ban mini derivatives contracts

LOKESHWARRI S.K.
Comment (1)   ·   print   ·  
Mini derivatives will facilitate retail investor participation.
Mini derivatives will facilitate retail investor participation.

Once in a while, the stock market regulator, the Securities and Exchange Board of India, comes out with a directive that is so puzzling that it makes one wonder at the manner in which these decisions are arrived at.

SEBI’s recent circular discontinuing mini derivatives contracts on the Sensex and the Nifty is one such move. In a terse circular issued last week, the regulator said, “with a view to ensure that small/retail investors are not attracted towards derivatives segment, it has now been decided to discontinue mini derivative contracts on index.”

Not much is likely to be achieved by banning these contracts as they are quite unpopular with very low volumes. Most traders, including retail investors, prefer to trade in the regular contracts, and not the mini version due to higher transaction costs and lower liquidity on mini contracts.

It is also hard to envisage how banning these contracts will dissuade small investors from the futures and options segment. They will only move on to other derivative contracts.

The method in which these smaller contracts on derivatives were introduced in 2007 and now abolished, five years later, raises serious questions about the regulator’s decision-making process. Such haste in passing trading-related decisions has proved detrimental in the past too; the decision to allow co-location facilities at exchanges is one such instance.

Mini history

Towards the end of 2007, SEBI had given permission to exchanges to launch mini derivative contracts on the Sensex and the Nifty up to the value of Rs 1 lakh.

This was a wrong time to introduce these instruments since the bull market was at its frenzied best then and retail investors were also very active in the derivatives market. The regulator should have tried to suppress speculative retail activity then, instead of spurring it on.

Business Line had, on January 3, 2008, (http://www.thehindubusinessline.com/todays-paper/article1612201.ece) questioned the timing of this move.

Unpopular contracts

In the last five years, these contracts have not really caught the trader’s fancy. While Nifty November future traded 1,71,000 contracts on Friday, mini nifty future contract for the same expiry traded only 14,200 contracts. The difference is greater in options with around only 4,500 contracts of mini nifty call and put options traded on Friday against 30 lakh contracts of regular nifty options.

It was initially expected that the lower margin requirements for mini futures could act as a draw for investors.

While the initial margin for one lot of nifty is currently around Rs 20,000, one lot of mini nifty can be purchased with just Rs 5,000. But traders have not been drawn by this lower outlay since most derivatives traders play the market with far greater capital. They prefer to stick to contracts with higher volumes.

This has resulted in lower liquidity and higher bid ask spread in the mini contracts. Another reason that renders these contracts unattractive is the flat brokerage charged by brokers for all contracts.

Despite the value of mini nifty being half of the regular nifty contract, the brokerage charged is the same. This results in lower profit in trades done on mini nifty or Sensex.

Brownie points

The brokers and exchanges are unlikely to protest this move as their volumes are not likely to be impacted much through this ban. The trading community will also not really miss these contracts. The regulator could thus be aiming for some brownie points through this gesture.

While their introduction in 2007 was not timed right, once launched, SEBI should let them be. The anomaly in brokerage rates in these contracts should be addressed at the intermediary level to make them more effective. Smaller derivative contracts, especially on indices and commodities, are quite common worldwide.

SEBI’s committee set up to suggest reforms in the derivatives market had even recommended mini derivative contracts on all stocks. These smaller valued contracts help hedge portfolios of smaller value. They are used not just by small investors but by institutional investors too.

At a time when retail investors are withdrawing from equity investing — as reflected in poor response to initial public offerings, falling cash volumes and outflow from equity mutual funds — the regulator should make sure that it facilitates greater retail participation and one way to do so is to make mini derivatives available that can be used by retail investors for containing risk.

More deliberations

The ruling on mini derivatives contracts also brings into focus the process followed in formulating rules that affect trading on the markets.

More deliberations seem to be required and the implications need to be weighed more carefully before peremptory circulars are issued to exchanges.

Views of not just the exchanges and intermediaries but also investors and traders are needed to help arrive at the optimum decision.

A similar rush was displayed in first allowing direct market access and algorithmic trading and then allowing exchanges to host co-location facilities close to their servers. The regulator is now striving to salvage the damage done by these decisions.

(This article was published on November 25, 2012)
XThese are links to The Hindu Business Line suggested by Outbrain, which may or may not be relevant to the other content on this page. You can read Outbrain's privacy and cookie policy here.

Comments:

NO, MINI DERIVATIVES SHOULD NOT BE STOPPED. IT IS ATTRACTING CUSTOMERS.

from:  JAYASREE
Posted on: Nov 26, 2012 at 13:52 IST
This article is closed for comments.
Please Email the Editor


O
P
E
N

close

Recent Article in Opinion

A-I profits may dip

The first board meeting of Air-India chaired by Mr. Russi Mody today passed the annual accounts of the airlines for 1993... »

Comments to: web.businessline@thehindu.co.in. Copyright © 2014, The Hindu Business Line.