Hello Nithin Sir, saw an article in today’s (8th Sept '17) Economic Times which was about SEBI asking for comments on making delivery of shares compulsory on stock options. You were quoted as supporting the move. Not much detail was given on this topic in the paper.
I reckon you know much about it since you gave your opinion to the newspaper on the topic. It would be great if you could share the details. What it was about and what is going on? What new regulatory bomb SEBI is planning to explode on us? How it is going to affect derivatives trading as we know it today?
The article said, the volumes of derivative trading is very high compared to equity and SEBI plans to “equalize” the deficit.
Just went thro the (stock lending & borrowing) SLB basics.
Looks like more margin, more taxes, more interest on borrowed stocks for traders. May be those who hold actual shares may benefit by trading F&O / Lending
This will not really be a bomb, it will probably help grow the market. Both future and option traders will be able to convert positions to physical delivery. Can potentially attract a new breed of traders/arbitrageur/hedgers to the market.
Let me give an example of how it can help. Today if a big prop trading house sees a shorting opportunity, they can keep selling futures all the way down, not having to worry about covering/buying back the contract (which typically supports the fall). They can just let it expire and settle by cash. If there was physical settlement, they would have to either buy back the future before end of expiry on the market, or deliver the underlying stock (by buying from the market). This will hopefully help reduce the steep falls that we see sometimes on our exchanges.
Exchanges in India declare trading turnover by contract value of options and not premium turnover. Hence the ratio of derivatives to equity is higher in India. So that report saying India is significantly higher than others in terms of derivative turnover is not right. Btw, the reason for higher derivative turnover is also because of a non-existent SLB market. Allowing physical settlement for derivatives can potentially also help grow the SLB market.
Most exchanges across the world use cash settlement. Some exchanges offer both options, while a few offer the physical settlement.
Physical Settlement is two sides of the same coin its have both Advantages and Disadvantages
Advantages :
1.Grow the SLB market.
2.Helps to curb excessive manipulation.
3.Become leading market.
4.Will able to discover equilibrium price because of physical settlement.
5. It will help for better alignment between cash and derivative markets.
Over a decade ago when derivatives trading started in Indian stock exchanges, it was decided that derivatives instruments must be introduced in a phased manner. This was following the recommendations in the L.C. Gupta Committee and JR Verma Committee reports. It was decided that all derivatives transactions on stock exchanges would initially be cash-settled. Physical settlement of derivatives contracts was not permitted that time because the stock exchange mechanisms were then not in a state of preparedness to deal with such settlements.
Like I said, only if a person held the position till close of expiry, yeah not only have demat but also either be ready to take delivery or give delivery of shares. The other option is to cover the futures or options positions on the market itself. Similar to how it works in compulsory delivery contracts on commodities (Gold, etc).
Security Lending and Borrowing Scheme (SLBS)
Short Selling means selling of a stock that the seller does not own at the time of trade. Short selling can be done by borrowing the stock through Clearing Corporation/Clearing House of a stock exchange which is registered as Approved Intermediaries (AIs). Short selling can be done by retail as well as institutional investors. The Securities Lending and Borrowing mechanism allows short sellers to borrow securities for making delivery.
So it applies only to positions allowed to expire and not to positions squared off before expiry. Right? If it is so then it is a good move for sure.
What about the option SEBI gave to mark a position as “not for expiry”. Kind of something like that. Don’t exactly remember the thing. How can we exercise this option (not to let the position expire)?
Where I can find the paper which sebi is talking about. I want more details how it is going to work. I feel I am interested. If it is like the commodity (gold, silver, others) delivery system, it can allow to hold a stock for much cheaper price than market.
Options can be bought with the minimum amount and earlier it took time for SEBI and Exchange to spread awareness about STT levied on In the money option exercised ( Which is now taken care of ) .
Same concern is here, small investor participating without understanding risk will ended loosing much then before.
Unlike the STT issue, the broker here will be in control of things. So the onus will be on broker to educate clients to square off if they don’t intend to take or give delivery. It will be similar to physical delivery contracts on commodities, has worked okay until now.
Risk is a Risk even if u held anything fr 1sec in derivatives market! It is not a question of beforeexpiry/afterexpiry. they r discussing mandatory physical settlement fr stock derivatives.
SEBI wants to curb blind risk taking by retailers & it sees more risk is present in stock derivatives compared to index derivatives. Remember, on Aug 10th so called heavyweight ICICICBank had crashed more than 5% in cash market. Just think abt wht wud hv hapnd if it had perculated to its futures with 2750 as lot size, even fr few seconds! Also, many of the pharma stocks which r in F&O are having field day very often with min 5% move.
Yes, i believe one need to hv demat to trade in stock derivatives too frm now onwards & it becomes obvious as SLB comes into picture!
Alternatively, large traders could either roll over short positions or perhaps, short the mid month directly. Maybe this can increase liquidity in mid/far month contracts.
Nithin, this move might help in SLB and it might also restrict the Big players to move the market in one direction till expiry. However will this actually reduce the FNO volumes, because people might not hold till expiry but trading will still happen. In fact volumes might only increase cause the big players might have multiple entries and exits now as they wont be holding positions till expiry.
It’s good move for retail investor to catch the trend, most of traders would have let the contract settled through exchange on expiry day, once this rule implements the majority of them will cover the position rather taking them into delivery. Again it’s complicated for both client & brokers. Brokers have to ensure before expiring all positions need to be square off or else it will be marked as delivery.
Initiality it will be complicated slowly slowly people will be used to it like MCX segment.
