Stock-based derivative trading gains traction

Analysts concerned about high-leverage in the system

Trading in the stock derivative segment is slowly picking up pace as investors get less risk-averse and much more confident about the market direction. Analysts said that investors were willing to take speculative positions on individual stocks by taking higher leverage, often without adequate hedges in the cash market. 

 

The uptrend in the market, which has seen benchmark indices move up by about 30% since January this year, has made investors bold enough to increase exposure in the derivatives segment, industry officials said.

 

“On the whole the markets are doing good and sentiment in the market has turned positive. So people are thinking that for the same amount why not take larger positional calls in stocks through derivatives than through the cash market segment,” said Mehraboon Irani, principal and head (PCG), Nirmal Bang Securities. 

 

As per data from the World Federation of Exchanges, the National Stock Exchange has seen the highest notional turnover in the stock futures and options segment in October this year. At over $134,327, the turnover on NSE is the highest followed by the Eurex and Bovespa at $98,931 and $90,691. The NSE has seen the highest notional turnover in stock futures and options since June this year.

 

While high networth investors (HNIs) dominate this category of investors, retail investors are also showing an interest in the segment, industry players said.

 

Besides willing individual investor participation, the rise in popularity of arbitrage funds and restriction of FII-participation in stocks has also led to an increase in activity in the stock derivatives segment, said analysts. Within the stock derivatives segment, the stock futures segment is more preferred by traders and investors, analysts said.

 

But some analysts believe that the rise in stock futures trading is a sign of worry as it increases leverage in the system.

 

“It is not a bragging point but a sign of worry that you are creating excessive leverage in the system. Our markets are far more volatile. If you have greater volatility, which is a function of local factors and also international factors, then having leverage positions in the market is not a great thing to have,” said Amit Rathi, MD of Anand Rathi Financial Services.

 

India is one of the few markets which trades in individual stock futures. In developed markets like the US, the leverage permitted in trades is capped. However, in India there are no such restrictions prompting people to take leveraged positions at much higher levels than is deemed safe for investors.

 

“And in most countries like the US, your leverage ratios are restricted so you cannot borrow more than 50% against a stock. Here people were leveraging with 20% margin down. So, the leverage ratios are far greater,” said Rathi.

 

However, the industry is willing to look the other way as long as the trades generate higher revenues and higher volumes.

 

“I don’t think there is an active voice around this because in the short-term this is counter-productive to brokerages because volumes go down and commissions go down. I think regulators can play a more constructive role in trying to curb this because if you expect industry players to do it, it is unlikely to happen,” said an official with a domestic brokerage who did not wish to be named.