Markets to lose fizz

The Indian stock market seems to have come under the spell of the Ides of March. Whatever little fizz there was left in the market is expected to evaporate with the revision in the contract sizes in the derivatives segment.

The average number of shares in a single contract has increased by three times from March, as per the Securities and Exchange Board of India (SEBI) guidelines. Traders in the derivatives market, especially in the call and put options where most of the action has concentrated since September 2008, expect liquidity and volumes to dry up further, which will sedate the market even more.

Already, volumes have fallen by half to around Rs 40,000 crore daily from over Rs 80,000 crore in October 2007. But since the National Stock Exchange’s (NSE) Nifty index has also fallen by 56 per cent during this period, there is no decline in volume in real terms. So, are the traders’ fears real? Market experts say from March onwards the average value of a single contract will increase to Rs 2.9 lakh from Rs 1 lakh in February.

This would mean that a trader willing to have an exposure to the same number of contracts will have to pay greater margins now. “With the increase in the number of shares in a contract, the risk will go up (due to higher margin) and investors will like to reduce their risk in the current environment,” says V. K. Sharma, Head of Research at Anagram Stock Broking. He thinks that volumes will go down as there will be fewer participants willing to pay a higher margin.

However, Sandeep Tandon, Managing Director and CEO of Quant Broking, says: “There could be small impact on retail investors, but overall I don’t think there will much impact on volumes.”

According to Tandon, investors in derivatives market take position in terms of number of shares or value of contracts and they will continue to trade in these terms. So, a trader taking an exposure in 50,000 shares of Unitech or an exposure of Rs 5 lakh will continue to do so, he says. Tandon may be right as far as the derivatives market in general is concerned. But the same may not be true for various stock futures and options where the number of shares in a contract has increased 5-7 times. For instance, the contract size of IFCI, one of the leading stock futures, will increase 7 times to 15,760 shares from 1,970 shares earlier. Similarly, the lot size for Unitech futures will rise nine-fold to 9,000 shares from 900 shares. So for traders, even for a single contract, the margin requirement will rise in the same ratio as the increase in the number of shares.

The market participants have a bigger concern on account of the widening of bid and ask spreads of a stock future or options. Higher the liquidity in a financial instrument, lower is the bid and ask spread and vice-versa. A higher spread means more risk and price discovery for the contract will not be better. “It’s a slow death for the options market,” says Sharma.

The only silver lining amid the dark mood, say brokers, is that there has been no change in the lot sizes for Nifty index futures and options, which has remained at 50. Nifty index is the most active contract on the exchanges. But for other indices, there has been an increase in the lot sizes and their volumes are expected to take a beating like others.