F&O volumes may decline on tighter margin regulation
12-15% allocation is a must to counter volatility in equities
Afurther 20-30 per cent decline in retail derivatives volumes is likely as phase two of peak margin norms kicks in from March 1. Retail participation in the F&O segment — especially that for options writers on expiry days — has already been impacted owing to these norms, which became effective from December 1.
The derivatives turnover on weekly expiry days on the NSE in December in the index futures segment, for instance, came off 41 per cent over the previous month, while that for index options reduced 19 per cent, the data from brokerage Prabhudas Lilladher showed.
Peak margin rules dictate a short-margin penalty — ranging from 0.5-5 per cent of the shortfall per day — if brokers fail to secure the minimum margin for intraday positions.
Market regulator Sebi has effectively capped the leverage that’s possible in derivatives to four times the margin in phase 1 and a penalty is levied if margin blocked is less than 25 per cent of the minimum 20 per cent of the trade value (VAR+ELM) for stocks or Span+exposure for F&O. From March 1, penalty will be levied if margin blocked is less than 50 per cent of the minimum margin required.
The maximum intraday leverage that can be offered by a broker will keep reducing until September 1, 2021. After this, a broker can provide maximum leverage that is equal to Span+exposure for the F&O segment and VAR+ELM for the cash segment.
SPAN is standard portfolio analysis of risk, VAR is value at risk, and ELM is extreme risk margin — metrics used to determine the risk to investment for a particular security.
“Until February 2021, we will not be affected directly as the leverages we offer won’t change. But after that and especially after intraday leverages are completely removed by September 2021, our intraday business will be affected by at least 30-40 per cent, which can potentially mean around 2030 per cent hit in terms of overall revenue,” said Nithin Kamath, CEO, Zerodha.
The F&O segment contributes about 40-60 per cent to revenues of retail brokers.
On February 9, the stock exchange NSE warned brokers against entering into arrangements with non-banking financial companies to fund the peak margin requirements of their clients. It said trading members should not finance or act as a conduit or front for financing any secondary market transactions or margin requirements for their clients unless it conforms to the regulatory provisions of Margin Trading Facility and Securities Lending and Borrowing mechanisms. This may further plug the loophole brokers used for financing clients.
To be sure, overall derivatives volumes have surged to record highs in the last three months, despite the peak margin norms, averaging Rs 38 trillion compared with Rs 20 trillion in 2020.
Until December last year, it was common for brokers to offer leverage of 4-8x for intraday trading in the F&O segment, going as high as 30-40x. The end-of-day margin reporting allowed broking customers to take intraday positions with margins far lesser than VAR+ELM or Span+exposure.
The additional intraday leverages that were offered through products such as MIS would be squared off before the close of trading hours, ensuring there is no margin penalty on the end of the day open positions.
Gold has lost some of its shine in recent days. Its spot price stood at ~46,360 per 10 grams on Tuesday — down ~9,541, or 17.1 per cent, from the high of ~55,901 per 10 gram reached on August 7, 2020.
Losing lustre
A rise in US treasury yields has sent the yellow metal tumbling. Gold has a negative correlation with real interest rates. Low or negative real interest rates are positive for gold by reducing the attractiveness of holding bonds.
The strengthening of the dollar against major currencies recently is another reason. Since gold is priced in dollars in the international market, the strengthening of the greenback leads to fall in the price.
Expectations of a larger fiscal stimulus package have added to the pressure. Ajay Kedia, director, Kedia Advisory, says, “The stimulus will lead to increased liquidity in the market. It will also result in increased buying of risky assets. Money may move away from gold, as has happened in recent months.”
The ongoing vaccination drive is another reason. Tarun Birani, founder and chief executive officer, TBNG Capital Advisors, says, “The optimism that vaccines will aid global economic recovery has also caused gold prices to soften.”
A lot of funds are flowing into bitcoins, which has risen more than 90 per cent in the current year. A lot of the money that would otherwise have been allocated to gold has moved to bitcoin.
Has the rally ended?
Experts believe it may be too early to turn pessimistic on gold.
“Keeping the geopolitical and traderelated tensions, and overall economic uncertainty due to the pandemic, gold’s outlook remains positive,” says Kedia.
Some experts expect gold to decline further and then stabilise.
Naveen Mathur, director of commodities and currencies, Anand Rathi Share & Stock Brokers, says, “There may be a ~2,000-fall in India. Globally it may decline from around $1,800 per ounce (oz) to $1,750 per oz. Its investment appeal has lessened to an extent as people have moved to risky assets. But until we are out of the pandemic, gold’s price may not decline too much. Rather it may stabilise.”
What should investors do?
Experts say the correction has provided a good buying opportunity to investors. “You should always maintain an allocation to gold as it has the ability to counterbalance any correction in the equity market,” says Mathur.
New investors, who don’t have an allocation to gold, should use the current correction to build it. Kedia says investors should maintain a 12-15 per cent allocation.
Existing investors, who already have an allocation, should not think of exiting. “Those who have already bought gold should continue to hold it and maintain their optimal asset allocation to the yellow metal in their portfolio,” says Birani. If their allocation has dipped below the ideal level, they should accumulate gold in a staggered manner.
The best avenues for investing in gold are sovereign gold bonds (SGB) and gold exchange-traded funds (ETFS). SGBS are government-backed securities, which pay 2.5 per cent fixed rate of interest per annum on the initial amount invested. SGBS, however, are not liquid. In the case of gold ETFS, investors have to pay an annual expense ratio, but they are very liquid and one can exit them easily.