Unravelling stock exchange turnover

Market observers have been flummoxed in recent years by the stagnating volumes in the cash segment, while derivative volumes have been hitting the roof. A closer look at the way exchanges compute the turnover figure could help in understanding the actual trading volume on our bourses.

The widely tracked numbers

It is generally presumed that retail investors predominate in the capital market segment while traders rule over the derivative market. Combined daily average turnover in the capital market segment is stagnating over the last couple of years.

While the average daily cash turnover in 2009 was around Rs 21,000 crore, it declined to around Rs 19,200 crore by 2010. This number has shrunk further in the first four months of 2011 to Rs 16,000 crore.

In stark contrast, the derivative volumes on the exchanges have been growing by leaps and bounds. The average turnover for 2006 at around Rs 29,000 crore has grown manifold to Rs 1,36,000 crore in 2011. That the derivative turnover is growing at a healthy clip is also reflected in the fact that average volumes in this calendar is up almost 36 per cent over last year.

Misleading numbers

There is little doubt that the galloping turnover in futures and options is spell-binding. But it needs to be understood that the derivative turnover recorded by exchanges is just the notional value of the securities traded. Actual money exchanged in these trades is a fraction of that reported by exchanges.

The reason being that derivative segment represents leveraged trading wherein traders take exposure many times their actual capital outlay. For instance, for buying one Nifty future contract worth Rs 2, 50,000, a trader would have to pay only the margin of around Rs 25,000. The multiplier is much higher in the case of options. The outlay for buying one Nifty option contract for the same value could be as low as Rs 3,000.

However, stock exchanges tend to report the entire exposure of the traders as their derivative turnover and not just the future margin or the option premium, which is the actual outflow for traders. For reporting the turnover of an option contract, the exchange would multiply the lot size with the strike price adjusted for the premium paid. For futures too, exchanges calculate turnover by multiplying the lot size with the contract price while the trader needs to pay just the margin.

The difference between the capital employed by traders and the exchange turnover is exacerbated due to the fast growth in options turnover in recent years. Options that accounted for less than 20 per cent of the derivative turnover in early 2008 have risen to over 70 per cent in the first quarter of 2011. So if we were to consider only the capital that traders use for playing in derivatives, daily turnover in this segment could be less than Rs 10,000 crore.

It can be argued that the exchange turnover captures the actual exposure that a trader takes. But the World Federation of Exchanges cites the number of contracts traded as the exchange volume. The turnover as reported by our exchanges is reported as ‘notional value of contracts traded'. This appellation could give the right picture to market observers.

Capital market Segment

In the capital market segment, there are two components to the turnover — the delivery-based transactions that end in exchange of shares and the non-delivery based transactions that are squared within the settlement. In the case of delivery-based transactions, the exchange turnover data captures the actual money paid by the investor or trader. .

However in non-delivery-based transactions, the cash deployed for the transaction could be just a fraction of that reported by the exchanges.

Delivery volumes

Delivery volumes on the NSE and the BSE ranged between 20 per cent and 30 per cent over the last five years. The balance 70-80 per cent per cent of the turnover represents transactions that do not end in delivery of shares. If we again shrink the non-delivery-based volume to the margins that traders pay for these transactions, cash volumes would also shrink significantly.

There is, however, no denying that volumes in the capital market segment (both investment-related and trading) are on the wane. In the period prior to the introduction of futures and options in 2000, trading made up 80-90 per cent of cash volumes on the bourses. It is possible that as the market matures, some of the traders in the capital market segment graduate to the more sophisticated futures and options segment. This could be one of the principal reasons for the stagnating volumes in the capital market segment.

Whither retail investors?

So where does that leave investors? India Inc has raised around Rs 19,000 crore from the primary market in 2009 and a humungous Rs 69,400 crore in 2010.

Retail investors also appear to be using the mutual fund route, especially the SIP products, to take exposure to stocks. Shareholding data of CNX 500 companies too shows that the share of retail investors remained more or less stable in recent years.

While the exchange turnover data can be used to discern trends in trading patterns, it falls woefully short as indicators of the money that investors and traders deploy in secondary market. The exchanges could consider labelling what they call turnover as notional value of shares traded so that market observers are not misled.