The chant for physical settlement in the equity derivative segment of Indian stock market is growing. This is on the back of cash market volumes reaching its lowest levels, due to a record crash in share prices, on Thursday.
The benchmark indices fell four per cent, which saw the cash equity market volumes on the BSE and NSE at 6.52 per cent or over Rs 13,000 crore of the overall equity trading of over Rs 1,88,000 crore. The rest 94 per cent of trading was seen in the equity futures and option (F&O) segment. Such low volumes in cash market were seen in 2008 when BSE index Sensex was trading at historic lows of around 8,000. On BSE, close to Rs 3,000 crore worth of volumes were recorded.
Stock brokers say after every big crash, volumes in cash segment dry down as genuine long-term investors are scared to enter market.
| THE BIG PLUNGE | ||||
| Rs for $1 | % Chg* | Sensex | % chg* | |
| 29-Mar-07 | 43.75 | -1.66 | 12,979.66 | 0.74 |
| 16-Sep-08 | 46.93 | -1.90 | 13,518.80 | -0.09 |
| 6-Oct-08 | 47.81 | -1.58 | 11,801.70 | -5.78 |
| 11-Nov-08 | 48.12 | -1.57 | 9,839.69 | -6.61 |
| 12-Nov-08 | 49.29 | -2.44 | 9,536.33 | -3.08 |
| 22-Dec-08 | 48.02 | -1.62 | 9,928.35 | -1.70 |
| 17-Feb-09 | 49.67 | -1.72 | 9,035.00 | -2.91 |
| 19-May-10 | 46.37 | -1.72 | 16,408.49 | -2.77 |
| 1-Jun-10 | 47.16 | -1.70 | 16,572.03 | -2.20 |
| 22-Sep-11 | 49.58 | -2.57 | 16,361.15 | -4.13 |
| * Over Prev close Source : Bloomberg Compiled by BS Research Bureau | ||||
Speculation and short-selling in market was high on Thursday as delivery-based volumes were not even half of the cash market trades recorded.
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According to experts, traders use thin volumes to their advantage.
“Currently, stock markets are in a precariously dangerous situation, amidst high uncertainty. Short-selling is healthy, but naked shorts that artificially suppress the stock price can deal a body blow to the entire system,” said Deven Choksey, managing director of K R Choksey Shares and Securities.
Chiragra Chakrabarty, director, financial advisory of Deloitte in India, said physical settlement would be favoured, as it could bring a intersection of markets in the actual sense.The original purpose of a derivative is to act as a hedging tool for risk management. “ A derivative is like a nuclear weapon. It can prove to be destructive, if not used in the right sense,” he said.
Short-sellers come together when there is excessive bad news or negative sentiment and lack of buyers. They manipulate prices by taking large short positions in the futures market nearing contract expiry — and then depress the formula-based settlement price, thus making a windfall on futures positions. This results in a deeper cut in share prices as there is no buying support for a falling stock.
Short-sellers can do this by paying a small margin money. It is for this reason why some of the stocks fell between 5-10 per cent even on Thursday.
Such manipulation can be prevented by introducing physical settlement or delivery-based system in derivatives. Under this, manipulators would know that if they artificially increase or decrease stock prices, counter-parties could impose delivery -- and they would have to come to market to borrow stocks to deliver. This mechanism will provide cushion to stock, which otherwise fall like pack of cards. This will improve cash columes.
“Physical settlement,” said Kishor Ostwal, managing director of CNI Global Research, “will reduce excessive volatility and improve cash market and delivery volumes.”
The Chicago Board of Trade, from where futures and options (F&O) originated, has physical settlement of derivatives trade. That apart, most developed markets in the world follow the same practice. Due to these arguments by market players, the Securities and Exchange Board of India introduced physical settlement, but left the choice on stock exchanges to implement. However, there has been no indication from NSE, the leader in derivatives, to shift.
Initially, when F&O was introduced in India, cash settlement was allowed so that our markets could develop swiftly. However, Indian markets are no longer craving for attention as they are on the investment radar of the entire world. So, adoption of the physical settlement could only go a long way in improving efficiency.