So what’s BSE’s flagship index again?

The exchange's leadership team now seems to think that a shift in focus is necessary

The resounding answer to the above question will undoubtedly be ‘Sensex’. Even BSE Ltd’s website refers to the Sensex as its flagship index and ‘the barometer of Indian capital markets’. But the exchange’s leadership team now seems to think that a shift in focus is necessary, at least as far as its strategy for the derivatives market is concerned.

Since 1 August, it has reduced focus on Sensex products drastically and significantly increased efforts on building liquidity on BSE 100 contracts. As a result, trading on the BSE 100 index has accounted for the majority of BSE’s derivatives turnover this month. Options contracts with a notional value of 28,740 crore changed hands last Friday on the exchange, of which contracts worth 28,720 crore or 99.9% had the BSE 100 as the underlying index. And while Sensex futures dominated the index futures segment till late last month, futures contracts on the BSE 100 now account for 50% of index futures trading on the exchange.

Trading on BSE’s derivatives segment is totally influenced by incentives doled out by the exchange. So traders (mainly registered market makers) converge on products that are incentivized, while ignoring the rest. Last month, the incentive scheme for Sensex options ended, while the incentives for trading Sensex futures were curtailed. Simultaneously, trading in BSE 100 options and futures was encouraged through a new incentive programme effective 1 August.

Given the long history of the Sensex and the sentimental value attached with it, the shift in focus is intriguing. Cynics will argue that the change in strategy was forced upon the exchange, since the incentive scheme for Sensex options completed its Sebi-approved six-month limit and could not be extended. Unless the exchange replaced it with another scheme for another product, overall volumes would have crashed and the exchange’s hard work in the past year would have come to a naught. After all, as pointed earlier, there still is barely any genuine trading interest in the exchange’s derivatives segment—nearly all trades are entered into by market makers to earn the incentives on offer.

Be that as it may, the shift in focus to the BSE 100 may well work to the exchange’s advantage. While the Sensex has a long history, it’s becoming increasingly difficult to see it as a barometer of India’s stock market. It now accounts for only 47% of the market capitalization of all listed stocks on the BSE. The BSE 100 does far better with a 72% representation, as well as having exposure to more industries.

Another factor that is said to be working in favour of the index is that its value is extraordinarily close to that of the Nifty, which is the most popular equity derivatives product in the country. The BSE 100 closed at 5,279 on Monday, while the Nifty closed at 5,283. Additionally, the two indices are strongly correlated. Based on the above logic, the strategy seems to be to offer a product that mimics the Nifty, at a far lower cost.

In the individual stock derivatives segment, the exchange has chosen to differentiate, offering physically settled contracts at first and now following it up with a cash futures arbitrage product, which is akin to a fixed income product. The cash futures arbitrage product debuted on Monday and helped generate some volumes on the otherwise illiquid stock futures segment.

The $20 million question (that’s the amount BSE doles out in incentives on a yearly basis) is if these new strategies will work. While the above mentioned products are interesting, unfortunately for BSE, it hasn’t yet been able to attract genuine trading interest. It will soon be a year since the market making schemes were introduced and while volumes have picked up, most of it is accounted for by proprietary traders who have registered as market makers. There is absolutely no institutional participation yet. And the experience with Sensex options and futures has shown that volumes fall drastically when incentive schemes are withdrawn or curtailed. But hope still floats. As an old-time BSE broker-member puts it, “At least the exchange can’t be faulted for not trying."

Your comments are welcome at inthemoney@livemint.com

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