The positive feedback loop

SMARTSHARE

Poker is one of the few "export-quality" US sporting pastimes. A combination of exciting TV programming and ease of play on the Net has triggered exponential market growth.

This is a feedback loop "" more players are chasing more money and their presence is bringing in even more money and new players.

Similar dynamics operate in conventional financial markets: good trading platforms, better information dissemination, more liquidity and more participants create positive feedback loops.

In India's equity markets, daily volumes have grown from an average of Rs 2,500 crore in 2003 to Rs 10,000 crore now. Derivative market volumes have grown at even more stunning pace. In 2003, the F&O segment also did around Rs 2,500 crore per day. Nowadays it registers Rs 34,000 crore "" that's 1,400 per cent expansion.

Playing poker and trading financial assets require roughly similar skill-sets and carry roughly similar risks. Anybody who has been successful at both will assure you that playing poker for a living is less risky than trading.

The motivation is the same "" nobody plays poker or trades for pleasure (though you may derive much joy from both activities); they do it to make money.

There are many more traders than poker-players. Poker has regulatory and image issues (it's illegal in many places and even poker champions are not favoured clients at shaadi.com). Equity markets can absorb far larger volumes of cash.

In India's financial environment, a secondary bond market doesn't exist for all practical purposes; forex trading is difficult and so is investing overseas.

Every other nation with bourses of comparable size (there aren't too many) offers better bond markets and forex trading mechanisms. So the money concentrates on stocks and equity derivatives.

Outside the top 200-odd shares and indices, most of which are available on F&O, the secondary and tertiary listed companies aren't big enough to absorb significant sums of cash. There is also less credible information available about them.

Inside the charmed circle of the F&O stocks however, a near-perfect setup for positive feedback exists. There's quality information, excellent trading systems, high liquidity, good leverage and lots of participation.

India generates more stock futures volumes than anywhere else in the world. You cannot efficiently short in Indian spot markets because stock-lending mechanisms are messy. But you can sell stock futures at 15-20 per cent margin. Indian stocks often fluctuate 2-3 per cent per session leaving room for hefty returns.

Often, you find riskless arbitrages. For example, a stock future may trade at 1 per cent premium to spot price within 3-4 sessions of F&O settlement.

Buy the cash underlying and sell the future, reversing the trade as prices converge at settlement. This sauda-ultasauda cancels out price fluctuations and locks in a tiny gain, post-brokerage. That gain annualises to near 50 per cent.

The minimum commitment is to buy the equivalent of an F&O trading lot in the cash market and put down the margin for the futures trade as well. You'll need around Rs 4 lakh in your arb warchest.

Even if such a position is taken at the beginning of a settlement, a 1 per cent differential annualises to double-digits returns at zero risk. That's a lot better than FDs and it's a mechanical exercise. You can do it yourself. Or, you can invest in the few mutual funds that carry a mandate to do this.