Home / Market / Stock-market-news /  Traders, investors increasingly betting on derivatives segment

With the equity markets becoming more volatile, traders and investors are increasingly placing their bets in the derivatives segment, leading to a sharp rise in the segment’s turnover compared to the cash market. The derivatives segment comprises futures and options (F&O) contracts.

Currently, the derivatives turnover is more than 14 times that of the cash market. In 2011, it was less than 10 times. This shows that while investor activity has risen in capital market, the bulk of the increase has been in the derivatives market.

A major portion of derivatives trading is on account of proprietary trades and so can be considered speculative.

In September, the combined derivatives turnover of the National Stock Exchange of India Ltd (NSE) and the BSE was more than 30 trillion, against the cash segment turnover of 2.57 trillion. In June and July, the F&O segment turnover was more than 15 times the cash turnover.

“The trend can be primarily attributed to the rise in the share of options over the years," says Bhavin Desai, associate vice-president of equity derivatives, Motilal Oswal Financial Services Ltd.

The structure is such that the exposure created is significantly higher than the margins required to create the exposure, Desai added. The margin in an options contract is such that a trader can buy a contract of 2 lakh or more by paying a margin as low as one-tenth of the contract value.

According to Securities and Exchange Board of India (Sebi) data, options trading constituted around 83% of the total derivatives turnover in the current calendar year. The rise in the derivative turnover coincides with increased volatility in the equity market.

The increasing volatility is evident from the movement of the VIX index, a measure of the market’s expectation of stock market volatility over the next 30-day period. This year, for instance, saw huge swings in the VIX index as July saw a rise of 69% followed by a fall of 17% in August. In the current month, VIX has lost nearly 16%.

The current calendar year also saw huge swings in the benchmark indices. The 30-share Sensex traded between a high of 30,024.74 and a low of 24,833.54 points. In January, the index gained more than 6%, while in August it shed 6.51%.

On Wednesday, the Sensex lost 171 points to close at 25,822.99. The index has already lost 2.4% in the current month. While high volatility is the outcome of many factors, an increase in speculative derivative activity can play a role in it.

A majority of the F&O turnover is generated by way of proprietary trading by brokerages and are speculative in nature.

Sebi data shows that 51% of the total derivatives turnover of NSE was by way of proprietary trading in 2015. On BSE, such trading accounted for 92% of the total F&O turnover between January and April. Between May and July, its share rose marginally to 94% on BSE.

Patrick Young, executive director at DV Advisors, a Europe-based capital market advisory firm, says it is not uncommon to find derivatives proving hugely popular compared to the cash markets, as even simple F&Os enable all sorts of risk transfer and speculation, which in turn brings in the potential to gain from arbitrage between the cash markets and the derivative markets.

In October last year, when the Sensex gained nearly 5%, F&O turnover was pegged at nearly 19.51 times that of cash segment. Thereafter, in December the correlation was nearly 18 times when the Sensex lost 4.16%.

“Derivatives merely exemplify the interest in Indian markets and their future, Moreover, there is evidence that growth in derivatives also makes cash markets deeper and more liquid, as it enables risk transfer," says Young.

Interestingly, brokerages are now eyeing this opportunity and launching innovative schemes to capitalize on the trading behaviour.

Earlier this week, ICICI Securities Ltd launched a scheme called “bullet trade" wherein customers need not pay any brokerage for derivative trades squared off in five minutes. According to a statement by the domestic brokerage, empirical research on the emerging trading behaviour showed that customers are now quickly entering and exiting trades.

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