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    Should F&O lot sizes increase? Sebi needs views by tomorrow

    Synopsis

    India’s derivatives-to-cash turnover ratio in equities has gone up to 15.59 times in FY17.

    ETMarkets.com
    NEW DELHI: Legendary investor Warren Buffett calls derivatives the ‘financial weapons of mass destruction’.

    Yet, individual investors account for about 26 per cent of equity derivative trades in the Indian market and 60 per cent of turnover in the non-institutional, non-proprietary category.

    Within that, options dominate with 83.61 per cent of total derivative trading volume. Proprietary trades contribute 43 per cent of total volume.

    In a country where equity as percentage of total household savings is as low as 3.8 per cent and knowledge about complex derivative products is limited, individual investors are often at risk of unethical sales practices.

    India’s derivatives-to-cash turnover ratio in equities has gone up from 11.88 times in FY13 to 15.59 times in FY17, compared with Japan Exchange Group’s 1.9 times, Moscow Exchange’ 3.92 per cent and Hong Kong Exchange’s 7.23 times.

    Image article boday


    The equity derivatives market in India is 15 times the size of the cash market, which makes Sebi to suspect excessive speculation in the market.

    But that’s not abnormal, says G Chokkalingam, Founder at Equinomics Research & Advisory. “Globally, derivatives are more popular than the cash market.”

    He says the problem in India is that serious investors are a minority; most have a trading mindset.

    “The same mentality is also visible in the cash segment, where deliverables are to the tune of 10-18 per cent. You can’t do much about it. What is required is more investor awareness about products and steps to pursue investors to invest for the long term,” he said.

    This July, market regulator Sebi released a discussion paper, seeking to develop a product suitability framework to ensure that individual investors have a safety net. It sought public comments on the same, for which the deadline ends on Thursday.

    Market veterans say the proposed framework could take the form of differential contract sizes and open positions. Some traders also suspect Sebi could tweak margin rules for individual investors.

    There are speculations that the regulator may also propose doubling the lot size for a contract to Rs 10 lakh from Rs 5 lakh currently. The idea behind this is to make futures and options unattractive to retail investors, who do not fully understand the risks associated with them.

    Currently, lot sizes for equity derivatives contracts are fixed in such a manner that the contract value on the day of the review is within Rs 5 lakh-10 lakh range.

    Nirav Chheda of Nirmal Bang Securities said derivative trading looks more lucrative to investors as buying options requires less capital. Also, in options trade, securities transaction tax (STT) is charged not on the notional value of options, but on the premium.

    Chheda does not believe a hike in taxes in derivatives or increase in lot sizes can force investors to look at the cash market. "If intraday trading is banned in derivatives, it might cause some shift," he felt.

    Not everyone agrees increasing lot size is the right solution to the problem. “It may not be prudent to raise the lot size, as it will not improve risk profile of the product. However, slightly raising margins and maintenance (Span) margin may help prevent retail participants from going completely insolvent, as it will keep leverage under check,” said Milan Vaishnav, CMT at Gemstone Equity Research & Advisory Services.

    In the existing format, a transaction in cash market costs an investor 10 times more than what it does in futures.

    Market watchers say a brokerage structure wherein investors get a reduced transaction cost while buying in cash could be an answer. Financial intermediaries can be compensated with increased brokerage (transaction cost) in futures options, they say.

    Image article boday

    Also, trust is an issue for investors in the cash market. On an average, BSE suspends 60-70 stocks annually and most of them generally trade in the cash segment.

    “The recent ban on 311 stocks is a case in point. Some may find themselves trading in companies with nil sales and with market-cap of Rs 300-500 crore. Eventually, people have to shun short-sightedness and be investors,” Chokkalingam felt.

    He said with such stringent steps, the market regulator may improve cash market participation and push investors to look at balance sheets


    Sebi in a study found that 14.4 per cent of individual investors, who contribute 2.5 per cent of the total turnover in the equity derivative segment, do not trade in the cash market, which is considered less risky than derivatives.

    Image article boday


    Besides, approximately 68 per cent of total individual investors who trade in equity derivatives fall in the Rs 2 lakh plus trade category in cash market.



    ( Originally published on Aug 09, 2017 )
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    (What's moving Sensex and Nifty Track latest market news, stock tips and expert advice, on ETMarkets. Also, ETMarkets.com is now on Telegram. For fastest news alerts on financial markets, investment strategies and stocks alerts, subscribe to our Telegram feeds .)

    Download The Economic Times News App to get Daily Market Updates & Live Business News.

    Subscribe to The Economic Times Prime and read the Economic Times ePaper Online.and Sensex Today.

    Top Trending Stocks: SBI Share Price, Axis Bank Share Price, HDFC Bank Share Price, Infosys Share Price, Wipro Share Price, NTPC Share Price

    ...more
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