Mumbai: The National Stock Exchange (NSE), India’s largest stock exchange, is fine-tuning the facility of rolling over derivative contracts on its platform.
The derivatives head at a foreign brokerage, who didn’t want to be named, said NSE has informed some large institutional brokers that mock trading for the new facility will begin on 2 September. The live trading could begin as early as the last week of September, when the September series of derivative contracts expire.
Calendar spreads: The NSE building in Mumbai. Live trading of rollover contracts could begin as early as the last week of September. Photograph: Abhijit Bhatlekar / Mint
This could be a precursor to genuine “calendar spread” or rollover contracts, which allow customers to buy and sell near- and far-month contracts in one transaction.
An email sent by Mint to NSE didn’t elicit a response.
The Singapore Exchange, which also offers trading on Nifty futures, already provides calendar spreads. The market share of daily Nifty futures volumes in Singapore has climbed from about 1% in October 2007 to 11% in July, after the capital market regulator put restrictions on participatory note issuances last October.
In India, much of the volumes in equity derivatives centre around the contract that expires in the same month, although traders have the choice of entering into contracts for the next month and the month after. These contracts are called near-month contracts. Since liquidity is centred around near-month contracts, most traders take their positions in this series.
In case of index options, there is wider choice, with expiry months being as far as three years, as well.
Even traders who want to keep their positions open for a longer time frame first buy a near-month contract and then carry over or roll over to the next month, by selling the existing position and creating a new position in the next month’s series.
Such rollover activity picks up about seven-eight days ahead of the expiry and can be quite cumbersome not only for traders but also for brokers who execute these deals. Currently, brokers place two separate orders in the trading system— one to offset the existing position in the near-month contract, and another that creates a new position in the next month’s series.
With calendar spreads, the two orders can be placed at one go. Although NSE offered this facility earlier, the broker said the order could only be placed under the “immediate or cancelled”, or IOC, category.
IOC refers to orders which are cancelled automatically by the trading system, if they are not executed immediately after the order is entered.
Since calendar spread orders involve two separate orders, there is a possibility that one of the two orders gets executed and the other gets cancelled because prices in the trading system changed. This is why there are hardly any users of the calendar spread facility on NSE.
The broker said NSE now plans to remove the IOC condition and make such orders “through the day”. Its use is expected to pick up after the modification.
However, the traders are asking for more. They’d rather have calendar spreads trade as a separate security than just be a facility to place orders.
“There has been a longstanding demand from foreign players to introduce rollover contracts,” said C.K. Narayan, head of derivatives at ICICI Securities Ltd. “This contract is widely used in other markets, especially those in South-East Asia.”
Meanwhile, the same broker said that NSE’s move to change the calendar spread order facility could be a precursor to introducing trading itself on calendar spreads, or what Narayan refers to as rollover contracts.
Let’s assume the Nifty August series is trading at 4,300 around the time of expiry and that the September series is trading at 4,325. Also, consider a trader who has a long Nifty position in the current August series and who wants to carry forward his position to the September series. Under the existing framework, a trader has to sell his August contract and simultaneously buy the September contract, and shell out the difference (in this case, Rs25). Similarly, a trader who had a short Nifty position would have to sell his August contract and simultaneously buy the September contract, resulting in a net income of Rs25.
With rollover contracts, the person with the long position would buy the rollover contract and the trader with the short position would sell the contract. In the above example, the trader with the long position will buy the August/September rollover, which is essentially the buy-September and sell-August contracts rolled into one. For this, he’ll have to pay the difference of Rs25. The trader with the short position will be on the other side of the trade and will receive Rs25.
The payout and receipt of both traders is identical to that in the existing framework except that traders now pay commissions on both transactions. With rollover contracts, they’ll be executing just one trade and will save commission on one leg of the transaction.
There are times when the near-month contract is trading at a higher price compared to the far month contracts. For instance, the August contract could be trading at 4325, while the September contracts trades at 4300. In such a scenario, the trader doing a long rollover will receive Rs25 as net income and the trader with a short position and wants to rollover will have to pay Rs25, exactly the reverse of the first example.
Once the rollover transaction is executed, the existing position in the August series will be cancelled, and the trader will be left with only an outstanding position in the September series.
According to brokers, institutional clients pay between three and seven basis points as commission for derivative trades. One basis point is one hundredth of a percentage point. For high-volume traders, 50% reduction in the commission for rolling over their positions is a big benefit.
There are other benefits as well. Currently, at the time of doing the two simultaneous trades involved in a rollover, if the markets are too volatile, traders may end up paying too much of a difference while rolling over. The rollover contract that NSE is planning will eliminate this. This will help not only traders, but also cut down unnecessary work for brokers, who now have to coordinate the two legs of the rollover trade separately.
In overseas markets, even derivatives on calender spreads are traded to take a view on interest rates in the money market. For instance, the Chicago Mercantile Exchange has listed options on Eurodollar calendar spreads, enabling traders to take a position on the direction and volatility of the one-year Libor spread.
NSE controls more than 95% of equity derivatives trading in the country and brokers say the lack of healthy competition has stymied the introduction of market friendly measures. “A valid question to ask is why the NSE didn’t think of this earlier,” says one expert on securities market infrastructure who didn’t want to be identified.
Competition from the Bombay Stock Exchange, Asia’s oldest exchange, is insignificant. Though BSE had introduced rollover contracts earlier, derivatives volumes on this exchange are very small and are no threat to NSE.