F&O – GETTING PHYSICAL!

about 3 months ago
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Today, when the market ended, it marked the last series of F&O series where 45 stocks, which are very liquid and most traded in the derivatives segment, were traded for the last time ever under the non-physical or cash settlement category. And yes, the Nifty clocked the best F&O series in the last six months today.

So starting tomorrow, all the 161 stocks traded in the futures and options (F&O) segment, will be delivered physically at the end of expiry unless squared off or rolled over.

This trading in cash gave the Indian stock markets the misnomer of being one of the largest casinos in the world. And now with all the 161 coming under non-cash or physical settlement, will this ‘casino’ image change?

When we say cash-settlement, what we mean is that when the contract expires, the traders – buyers or sellers, settle their position in cash; they do not take delivery.

SEBI brining this F&O under physical settlement was for mainly two reasons – put a lid on speculation and bring down volatility during the end of the expiry. But will it really achieve that?

When contracts require physical settlement, it will force traders to roll over positions, ahead of expiry. Yes, the situation of lumping rollovers at the end of the series will end and this in will mean lesser volatility. SEBI has thus brought down the wall between cash and F&O market, which in turn may actually lead to a drop in volume in both cash as well as derivative market.

And there are many examples from the developed countries where derivative markets are physically settled wherein around 99% of the trades are even then cash settled. Traders prefer to either square off positions ahead of the expiry or prefer to roll over to a similar contract but with a much longer duration. There is a very miniscule percentage of traders who end up taking or giving physical delivery of stocks.

In our markers, what we could typically see in F&O’s getting rolled over one week prior to the expiry rather than the fag end of the series. And we could also see volumes going to indices during the last week of the expiry. All in all, the last week of expiry, which is usually action packed, will now start looking bleak.

Yes, we could see it give a fillip to the SLB (securities lending and borrowing) mechanism which has been lying almost dormant. SLB mechanism means when the short seller falls short of the stocks required to be delivered, he can borrow the stocks from the institutional investors. Thus what we could see emerging eventually is F&O being used mainly for index positioning while stock-specific shorting could happen through SLB mechanism. This is the usual global practice in global derivative trading. The now non-existent SLB mechanism could get roaring alive with more traders using the SLB, developing liquidity.

Well, this is a good move in the right direction. There will be glitches and SEBI will have to eventually sort out the issue over minimum market lot size. But starting tomorrow, we can say that India is at par with the global markets and the casino part? Well, trading is gambling, so that remains!

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