Gives bourses flexibility of squaring off on maturity day.
In a move expected to improve liquidity in stock options, the Securities and Exchange Board of India (Sebi) has allowed stock exchanges the flexibility to offer either European-style or American-style contracts. At present, only American-style contracts are allowed in stock options.
Sebi’s circular, issued on Wednesday, says after opting for a particular style, a stock exchange shall offer options contracts of the same style on all eligible stocks.
A European option can be squared off only on the day of expiry (maturity). This is in sharp contrast to the American option, which can be squared off before expiry. While options are quite popular with the investor community due to limited downside, stock options have lagged in the Indian equity derivatives space.
| MORE OPTIONS MONTH-WISE TURNOVER IN Rs CRORE | ||||
| Month | Index future | Stock future | Index options | Stock options |
| January | 298,849 | 444,134 | 695,860 | 51,454 |
| February | 326,871 | 354,485 | 847,236 | 41,285 |
| March | 268,266 | 405,316 | 843,167 | 51,398 |
| April | 279,572 | 409,844 | 905,472 | 76,731 |
| May | 395,613 | 431,513 | 1,217,458 | 79,832 |
| June | 372,266 | 421,753 | 1,169,943 | 71,547 |
| July | 289,423 | 423,422 | 1,043,354 | 73,710 |
| August | 299,130 | 496,267 | 1,157,466 | 100,865 |
| September | 383,872 | 555,581 | 1,688,469 | 108,470 |
| October | 344,571 | 525,895 | 1,484,939 | 97,801 |
| Source: NSE Compiled by BS Research Bureau | ||||
In September, the stock options turnover was around Rs 1.09 lakh crore – the lowest when compared to stock futures, index futures and index options. Market participants attribute this to a large number of illiquid stocks. With European-style stock options, there’s a likelihood of more players entering the space, they say.
“European options will be good for sellers, as the assignment will happen on the last day,” says Siddharth Bhamre, fund manager (derivatives), Angel Broking. “In American options, they are vulnerable to gap-up or gap-down opening the next day. At present, only 25-30 stock options are liquid. European style options will improve liquidity in more stock options.”
The nod for European options contracts in equity derivatives comes on the heels of a similar approval by Sebi for currency options. In July, the regulator gave the go-ahead for launch of premium-styled European call and put options in currency derivatives.
The domestic currency over-the-counter market also has European-style contracts. While in theory, there is a fundamental difference between the two, a section of experts believes the difference is not much in a practical scenario.
“While American options can be exercised any time before maturity, it never is,” said a derivatives trader who wished not to be named. “It is instead sold, because by selling, one can get more than the intrinsic value. European options cannot be exercised before maturity but can be sold before maturity.” Intrinsic value is the difference between the exercise price and the market price.
If a stock exchange wants to switch back to American-style contracts, it can do so after Sebi’s approval. “After opting for a particular style of exercise, a stock exchange may change to another style of exercise only after seeking prior approval of Sebi,” said the circular.
