How does India’s fast-growing, exchange-traded derivatives market stack up against global derivatives markets? The Futures Industry Association (FIA) recently released volume rankings for 2009, according to which, the National Stock Exchange (NSE) has overtaken the Nasdaq OMX Group to become the seventh largest derivatives exchange in the world. FIA’s rankings are based on the number of derivatives contracts traded on an exchange, and include all forms of exchange-traded derivatives across asset classes. NSE’s equity derivatives volumes grew by only 17% in 2009 and the exchange would have fallen well short of Nasdaq’s total volumes, but for a sharp rise in its currency futures volumes, which accounted for one-fourth of total volumes last year.
The Nifty options contract is now the fifth largest equity index derivatives contract, up from 10th position in 2008 and 15th position in 2007. According to data released by the World Federation of Exchanges (WFE), NSE is the fourth largest equity derivatives exchange in the world, based on volumes in 2009.
One of the criticisms of this form of ranking is that NSE’s average contract size is far lower than those of most overseas exchanges, and that, in value terms, its ranking would be far lower. While a turnover-based ranking would be ideal, FIA does not provide such data.
WFE provides equity derivatives turnover data for a majority of exchanges, based on which NSE is the eighth largest equity derivatives exchange in 2009. WFE does not provide turnover data for Chicago Board Options Exchange (CBOE), but one can easily assume that CBOE’s turnover is far higher than that of NSE. Similarly, while NSE is the third largest marketplace for equity index options in volume terms, its position falls down to No. 7 in value terms. In the equity index futures segment, the exchange enjoys the third position in volume terms but ranks 10th in value terms.
Also Read Mobis Philipose’s earlier columns
The average contract size of the top 10 equity index derivatives exchanges is around $40,000 (Rs18.2 lakh), while that of NSE is just around $4,000. Even in the case of other Asian exchanges that are part of the top 10 such as the Korea Exchange and the Taiwan Futures Exchange, the average contract size is much higher at $16,000.
Graphic: Yogesh Kumar / Mint
Even so, being part of the top 10 derivatives exchanges in value terms is commendable, especially keeping in mind the fact that NSE ranks only number 16 based on its cash market turnover in 2009, according to WFE data.
It’s tempting to come to the conclusion that India has a well developed equity derivatives market. But it must be noted here that a large part of the turnover is in the index derivatives segment. Equity stock options have hardly any takers almost nine years after they were launched. And with single-stock futures, liquidity is now concentrated in a few large stocks.
The regulator’s decision to allow physical settlement may help the equity options segment. Currently, those who write a stock option face an overnight market risk, since they are intimated of the exercise of their option only after market hours. As a result, the option contract is settled at the current day’s prices, while the underlying cash market exposure can be settled only the next day. To cover for this risk, option writers would quote high premiums from option buyers, who in turn will stay away from the market. With physical settlement, the option writer can choose to settle the options trade by delivering the underlying securities and avoid this market risk.
Of course, this is not the only reason the stock options market hasn’t taken off, and there may be other initiatives exchanges may need to take to develop the market. But the broader lesson is that Indian stock exchanges and the market regulator can’t afford to rest in the knowledge that equity derivatives volumes have grown at a fast pace and now count among the top 10 equity derivatives markets globally.
Another reason it’s premature to call the market well developed is that product innovation is rather low. Some of the fast-growing, equity-related derivatives contracts globally haven’t yet been introduced in the country. These include derivatives on volatility indices and contracts with exchange-traded funds as the underlying. This column has argued for long that exchanges should be allowed more freedom in designing products. With some signs of competition in the stock exchange space, this may be a good time to allow exchanges to innovate and compete effectively.
In The Money runs every other Tuesday. We welcome your comments at firstname.lastname@example.org