Options remain illiquid

SMARTSHARE

The NSE pleasantly surprised the markets on Wednesday evening with its release of a fresh list of 31 stocks that are to join the elite Futures and Options (F&O) club from Monday the 14th.

With this, the list of stocks in the F&O segment has ballooned to 186. There are three indices, the Nifty, the Bank Nifty and the IT index, which are also traded in the segment.

On Thursday, 26 of these 31 new recruits rose with elan, on a day when the advance-decline ratio was in favour of decliners. Volumes rose 220 per cent on average for these stocks. While the price gains will evaporate, the volumes will come to stay. The exchequer will rake in more STT as a result.

While we continue to add to the list of permissible stocks for F&O trading, we are not doing anything to improve the liquidity of options. For the derivative markets to develop in earnest, it is essential that liquidity improves and the difference between the bid and the asking rate narrows. 
 

OPTIONS MARKETSHARE ACROSS THE GLOBE
Geography	Stock Futures %	Stock Options %
European Markets	33	67
USA	0.4	99.6
India	95	5

Currently, options would account for around 5 per cent of the total volume in the stock futures and options segment. The liquidity is better in the Nifty options, where the share is higher at 25 per cent of the total Index futures and options. But it pales in comparison to the market share of options in the European markets, where they account for a significant 67 per cent of the volumes in stock futures and options put together.

In the US, stock options would account for "" hold your breath "" 99 per cent of the stock futures and options volume. In the Indian markets on a given day, there is no volume in the stock options in 25 per cent of the eligible stocks.

Though stock options were introduced before the stock futures, in July 2001, they could never really take off. One of the reasons why real interest could never develop in stock options was that enough time was not given for them to develop. Four months later, in November 2001, stock futures were introduced.

But a bigger culprit is the large market lot concept. One may argue that stock futures have flourished with the same handicap. While the older generation understood the options, as it was prevalent in some parts of the country, the new day trader in particular has not shown the same understanding. So I suppose, at some level, the complexity of the options trading has resulted in lower volumes.

As in our markets, the day trader or individual investors play a major role compared to the Western markets, where institutional investors call the shots and the divide is explainable. A logical conclusion is that as the institutional business increases its market share in India, volumes could pick up in the options as well.

Even in the Index or stock futures, there is no liquidity in the next month and no volumes in the far month. Two weeks before expiry in any given month, the current month would account for around 95 per cent of the Nifty futures volume and the next month series for about 5 per cent and no liquidity whatsoever in the far month.

The best thing may be to do away with the concept of a market lot and then you will see improvement in the liquidity in the options trading. But if you do not want to do that, make it a round figure of 100 shares, irrespective of the price. If some rules need to be changed, let it be done in the larger capital market interest.

As the number of stocks increases, the open interest will rise. For a healthier capital market, it is essential that Puts and Calls are liquid.

This will give punters an easy exit route if their reading of the markets goes wrong. It is akin to the safety valves in a pressure cooker. If 95 per cent of the positions continue to be in futures without liquid options, the markets are sitting on a keg of dry powder that could explode at a time of its choice and liking.