No rea­son to ban mini de­riv­a­tives con­tracts

The Pak Banker - - Front Page - Lokesh­warri S.K

ONCE in a while, the stock mar­ket reg­u­la­tor, the Se­cu­ri­ties and Ex­change Board of In­dia, comes out with a di­rec­tive that is so puz­zling that it makes one won­der at the man­ner in which th­ese de­ci­sions are ar­rived at.

SEBI's re­cent cir­cu­lar dis­con­tin­u­ing mini de­riv­a­tives con­tracts on the Sen­sex and the Nifty is one such move. In a terse cir­cu­lar is­sued last week, the reg­u­la­tor said, "with a view to en­sure that small/re­tail in­vestors are not at­tracted to­wards de­riv­a­tives seg­ment, it has now been de­cided to dis­con­tinue mini de­riv­a­tive con- tracts on in­dex."

Not much is likely to be achieved by ban­ning th­ese con­tracts as they are quite un­pop­u­lar with very low vol­umes. Most traders, in­clud­ing re­tail in­vestors, pre­fer to trade in the reg­u­lar con­tracts, and not the mini ver­sion due to higher trans­ac­tion costs and lower liq­uid­ity on mini con­tracts.

It is also hard to en­vis­age how ban­ning th­ese con­tracts will dis­suade small in­vestors from the fu­tures and op­tions seg­ment. They will only move on to other de­riv­a­tive con­tracts.

The method in which th­ese smaller con­tracts on de­riv­a­tives were in­tro­duced in 2007 and now abol­ished, five years later, raises se­ri­ous ques­tions about the reg­ula- tor's de­ci­sion-mak­ing process. Such haste in pass­ing trad­ing-re­lated de­ci­sions has proved detri­men­tal in the past too; the de­ci­sion to al­low co-lo­ca­tion fa­cil­i­ties at ex­changes is one such in­stance.

To­wards the end of 2007, SEBI had given per­mis­sion to ex­changes to launch mini de­riv­a­tive con­tracts on the Sen­sex and the Nifty up to the value of Rs 1 lakh.

This was a wrong time to in­tro­duce th­ese in­stru­ments since the bull mar­ket was at its fren­zied best then and re­tail in­vestors were also very ac­tive in the de­riv­a­tives mar­ket. The reg­u­la­tor should have tried to sup­press spec­u­la­tive re­tail ac­tiv­ity then, in­stead of spurring it on.

Busi­ness Line had, on Jan­uary 3, 2008, (http://www.the­hin­dubusi- nessline. com/ to­days- pa­per/ ar­ti­cle1612201.ece) ques­tioned the tim­ing of this move.

In the last five years, th­ese con­tracts have not really caught the trader's fancy. While Nifty Novem­ber fu­ture traded 1,71,000 con­tracts on Fri­day, mini nifty fu­ture con­tract for the same ex­piry traded only 14,200 con­tracts. The dif­fer­ence is greater in op­tions with around only 4,500 con­tracts of mini nifty call and put op­tions traded on Fri­day against 30 lakh con­tracts of reg­u­lar nifty op­tions.

It was ini­tially ex­pected that the lower mar­gin re­quire­ments for mini fu­tures could act as a draw for in­vestors.

While the ini­tial mar­gin for one lot of nifty is cur­rently around Rs 20,000, one lot of mini nifty can be pur­chased with just Rs 5,000. But traders have not been drawn by this lower out­lay since most de­riv­a­tives traders play the mar­ket with far greater cap­i­tal. They pre­fer to stick to con­tracts with higher vol­umes.

This has re­sulted in lower liq­uid­ity and higher bid ask spread in the mini con­tracts. An­other rea­son that ren­ders th­ese con­tracts unattrac­tive is the flat bro­ker­age charged by bro­kers for all con­tracts.

De­spite the value of mini nifty be­ing half of the reg­u­lar nifty con­tract, the bro­ker­age charged is the same. This re­sults in lower profit in trades done on mini nifty or Sen­sex.

The bro­kers and ex­changes are un­likely to protest this move as their vol­umes are not likely to be im­pacted much through this ban. The trad­ing com­mu­nity will also not really miss th­ese con­tracts. The reg­u­la­tor could thus be aim­ing for some brownie points through this ges­ture.

While their in­tro­duc­tion in 2007 was not timed right, once launched, SEBI should let them be. The anom­aly in bro­ker­age rates in th­ese con­tracts should be ad­dressed at the in­ter­me­di­ary level to make them more ef­fec­tive. Smaller de­riv­a­tive con­tracts, es­pe­cially on in­dices and com­modi­ties, are quite com­mon world­wide.

SEBI's com­mit­tee set up to sug­gest re­forms in the de­riv­a­tives mar­ket had even rec­om­mended mini de­riv­a­tive con­tracts on all stocks. Th­ese smaller val­ued con­tracts help hedge port­fo­lios of smaller value. They are used not just by small in­vestors but by in­sti­tu­tional in­vestors too.

At a time when re­tail in­vestors are with­draw­ing from eq­uity in­vest­ing - as re­flected in poor re­sponse to ini­tial pub­lic of­fer­ings, fall­ing cash vol­umes and out­flow from eq­uity mu­tual funds - the reg­u­la­tor should make sure that it fa­cil­i­tates greater re­tail par­tic­i­pa­tion and one way to do so is to make mini de­riv­a­tives avail­able that can be used by re­tail in­vestors for con­tain­ing risk.

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