Opinion
What’s behind BSE’s decision to relaunch derivatives?
Summary
- It should be seen as an attempt to grab a share of a fast-growing market rather than an effort to fundamentally advance stock market efficiency
It isn’t surprising that the Bombay Stock Exchange (BSE) is relaunching derivatives on the Sensex and the Bankex with a reduced lot size and expiry on Friday, different from the Thursday expiry for the far more popular options from the National Stock Exchange’s (NSE’s) Nifty 50 and Nifty Bank indices. The BSE move should be seen as an attempt to grab a share of a fast-growing market rather than something that will fundamentally advance stock market efficiency or the larger public good.
It must squarely be admitted that derivatives on the stock market have emerged as a legitimized form of betting for Indians. Few of those trading in futures and options have exposure to the underlying securities or try to hedge the risk on their positions on futures with positions on options. Most trade as if they are gambling, based on pure speculation, using options to fuel their hopes of making big gains with small outlays (options cost a fraction of the price of the underlying security or index).
‘NSE remains largest global derivatives market for the fourth year’, was a popular headline this January. However, India trails many other economies on the total value of shares of listed companies, and the ratio of this market capitalization to the total value of the economy’s output.
The total market capitalization of listed stocks in India is about 100% of GDP, while the comparable figure for the US is close to 200% of GDP (the world average is about 133%). In current US dollars, the US economy is almost seven times the size of India’s. That means that the market capitalization of listed companies in the US is roughly 14 times that of their Indian counterparts.
Yet India is far ahead of the US when it comes to trade in derivatives. Some extracts from the 2022 market highlights of the World Federation of Exchanges, the global body of bourses, are telling. “Stock index options, which account for the highest share (41.8%) of derivatives contracts, recorded the highest increase in volumes (117.4%) of all product lines relative to 2021. Notably, stock index options traded at the National Stock Exchange of India increased 134.5% compared to 2021, amounting to 32.57 billion contracts, by far their highest annual figure in the last six years.
“After stock index options, currency options is the other product line which recorded three digit year-on-year increase (104.9%), mostly due to the same exchange, National Stock Exchange of India, where 98% of global volumes of currency options are traded and which grew 111% year-on-year."
Of course, these volumes refer to the number of trades and not their value. On that league table, India would be a small player.
The trade in derivatives is highly skewed in favour of NSE – 99% of derivatives trades take place on it since it was stripped of effective competition, at least in the currency derivatives segment, when MCX-SX lost steam after Jignesh-Shah-led Financial Technologies India ceased to have a role in the ownership and operation of the exchange.
Brokerage from trades in derivatives is the principal source of revenue for stock exchanges. BSE hopes to secure a larger share of this by revamping derivatives on its exchanges and having a different settlement day. On the day when trades have to be settled, trading patterns reflect the pressure arising from the nature of traders’ exposure rather than the fundamentals of the underlying securities. Adding a new settlement day would increase the duration of this disparity between the derivatives market and these fundamentals.
Derivatives serve those who speculate on the market — without them, it would be harder to hedge one’s risk. That said, pure speculation of the kind that drives the derivatives volumes on Indian markets serves to enrich only a tiny proportion of market participants, while the rest lose money to the thrill of making a bet.
