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Trading in overseas futures contracts risky

Trading in overseas futures contracts risky

Last month, BSE Ltd launched trading in futures contracts for overseas indices from four countries. Futures are securities created (derivatives) from the value of an existing financial asset like an index. This is part of a joint initiative by exchanges from BRICS (Brazil, Russia, India, China and South Africa) nations as an attempt to help investors in their respective countries to buy into overseas products directly.

Exchanges are constantly innovating products to improve liquidity and this is one such move. Let us find out how it works and moreover what you should know before you are ready to use the facility.

Whats the initiative?

Among other things, this initiative involves allowing cross-listing of index derivatives in specified exchanges across the five BRICS countries. What this means for us is that futures of the four foreign indices will be listed and traded on BSE. The four indices are Brazils IBOVESPA, Russias MICEX, Hong Kongs Hang Seng, and South Africas FTSE/JSE Top40.

Similarly, BSE Sensex futures contracts will be listed and be available for trade in the specified exchanges in the four countries.

How will it work?

Basically, if you want you can now buy and sell a IBOVESPA futures contract on BSE just like you buy a Sensex futures contract on BSE. The overseas exchange derivative contracts are also denominated in rupees, making it simple to trade. For each overseas derivative contract the details are specified separately and available on the BSE website.

Futures contracts typically have a last trading day or an expiry day by which time you should either pay cash and settle the trade or be ready to take delivery of the underlying assets. Since futures are mainly used as a trading tool, usually the contracts are settled in cash for any gains or losses on the expiry day. For example, in India, the expiry day is the last Thursday of every month.

For each overseas future listed on the BSE, the expiry day is specified separately. For example, FTSE/JSE Top 40 futures have an expiry on the third Thursday of the trading month. Similarly, the minimum ticket size for each contract is specified separately. The trade timings will match our local market hours of 9.15 am till 3.30 pm. The index futures contracts will be marked to market everyday and for settlement you will receive money next day.

The indices for which this facility is available are benchmarks in their respective countries. They have performed well in the last 10 years (see graph) and, hence, may be enticing for investors who want to diversify their portfolio. However, it is to be noted that in the same period, the Sensex has outperformed all these indices.

Also, given the uncertain global environment, the timing for launching this may be off the mark. Says Siddharth Bhamre, head (derivatives), Angel Broking Ltd, “At present we are seeing very little interest from investors in domestic futures and options, let alone international futures. This product can take a while to become popular and the timing of launch seems a bit optimistic."

With much happening in our domestic equity market, most analysts and brokers are not even tracking this product as of now, so there is little in terms of experience of what is good or bad for the trade.

What should you do?

As of now, this is a very new product and volumes are still very low. At present, the daily turnover for these contracts is less that 10 crore. Says Sudip Bandyopadhyay, managing director and CEO, Destimoney Securities Pvt. Ltd, “This is an interesting product and people are talking about it, but there is little actual trading interest, mainly because of the uncertainty surrounding global markets. Once things are clear, trading interest should pick up."

Keep in mind though that for investing in these products, you need to be aware not only of trade specifications but also about the dynamics in the respective overseas market. That requires some in-depth practical exposure or research.

It is not just the risk of an overseas equity market you are taking on, but also currency risk as the underlying asset is denominated in a foreign currency.

While there is a lot of interest in the BRICS economies and markets, as it stands now, this is a product only for domestic institutional investors, large brokers and ultra high networth individuals. You should wait and watch how trading in these futures picks up over the course of the year and if volumes improve, then there may be merit in undertaking additional research to aid your trade if you want to indulge in diversifying your portfolio.

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