Aggressive trading in F&O stocks immediately after they are introduced is fraught with risk, but returns can also be impressive.
Last Thursday, the NSE cleared 39 new stocks for trading in the futures and options (F&O) segment. This is routine. Every so often, the exchange reviews stocks to see if they meet requisite liquidity thresholds and it clears new sets of underlyings. These are seamlessly added to the thriving equity F& O segment.
Tracking stocks at the time they are cleared for F&O, it is easy to see that there is usually a beneficial effect on liquidity. Volumes pick up once the stock is notified. The effect on cash trading volumes is accentuated for several reasons. Circuit filters are removed once a stock enters F&O. It is also possible to short an F&O stock.
Higher volumes often lead to lower bid-ask spreads and that in turn sets up a virtuous circle for traders. There may or may not be an effect on price. This seems to be much more random than the generally noticed effect of higher trading volumes.
This new basket of 39 is a very mixed bag. There are many counters that seem overdue for F&O inclusion such as Concor, Balaji Tele, Opto Circuits, PTC, RIIL, Thermax, TV18. There are also plenty of counters that are not noted for being high volume. I would assume that the liquidity difference will be more notable in counters that were less liquid prior to notification.
Every time a new set is inducted, there is grumbling about unequal lot sizes. The NSE principle of trying to ensure market lots are all roughly the same initial value is logical enough. But inevitably, as prices change, the value of market lots change. The lack of uniform lots places an unnecessary burden on traders' memories. Instead of simply multiplying price by 100 (or some other uniform ratio) they have to calculate lot value with widely differing lots associated to every underlying.
There are two attitudes that seem to prevail when it comes to new inductions in the stock F&O list. One is to cautiously wait and watch and track the new stocks until it becomes evident, which ones have caught the market's fancy. This is relatively low-risk insofar as any derivative trading can be low-risk.
The other method is to plunge straight into the new counters from day one. This is much more fraught with risk until you have some idea of the sort of volatility and bid-ask spreads the new induction will develop.
But if luck is with you, the chances of high returns are greater in the first few weeks of a stock being launched in F&O.
The other new product that NSE is introducing is far more radical. Currency futures are long, long overdue. The RBI has always had an irrational fear of these instruments given that they can be offered as pure rupee products with no conceivable chance of "infecting" actual currency movements.
The NSE is apparently going to do just that. From the September settlement onwards, it will offer a set of 12 monthly contracts with each one tied to the RBI reference rate for settlement purposes. The RBI offers rupee reference rates for USD, Euro, Yen and sterling. It's as yet unclear whether the NSE will offer all four sets of currency futures. It doesn't appear from the circulars that they are likely to offer cross-currency futures (Yen-Euro, GBP-USD) - at least not yet.
The contract size is quite low - $1000, or roughly Rs 40,000. The margining system and mark-to-market mechanism will be very similar to equity and index F&Os. So it will be possible for retail traders to take positions as well as for institutions to structure products that suit hedgers with a long-term perspective. A quant trader can easily work out daily value-at-risk (VAR) on these and apply appropriate strategies.
Apart from naked speculation, currency futures offer quite a few hedging opportunities. The exporters and importers will presumably continue using the more serious $34 billion OTC market where complex structures can be put together.
But if somebody is taking an exposure in a forex-sensitive stock from the IT sector, or taking a CNXIT future, it could be offset with the new currency futures instruments. In the long-term, this is likely to become one of the most popular trading segments in the NSE portfolio.
