The demand for physically-settled equity derivatives can improve if long-term players like insurance firms are allowed to participate in that segment, says Vineet Bhatnagar, MD & CEO at MF Global Sify Securities. Excerpts from an interview with Mehul Shah and Chandan Kishore Kant.
We have not seen much demand for physically-settled derivative contracts on the Bombay Stock Exchange (BSE) so far. Why? If the participants in the futures and options segment are those who trade only for the price movement, then they are happy with cash-settled contracts. They have no inclination to either give delivery or take delivery, as they are in the market to play the price movement of a leveraged instrument, which is also a low commission instrument as against the cash market. In addition to index derivatives, even the single stock futures are relatively liquid in India, as compared to many overseas markets. So, short-term traders prefer cash settled derivatives in India.
The National Stock Exchange (NSE) plans to introduce derivatives on foreign indices like Dow Jones Industrial Average (DJIA) and S&P 500. Which kind of demand do you see for these products among local investors? The demand for rupee-denominated, local-exchange traded derivative contracts on foreign indices will depend on the local trader’s need to diversify his portfolio. If he is happy with the return on his local portfolio, either because of the price volatility or because of the general underlying economy being in a bullish trend, there might not be any compelling need for an Indian trader or investor to trade in other overseas markets. But, if a trader, either for reasons of diversification or because he has started looking at global markets in a way that the news-related items affect multiple markets almost in one direction, then he can exploit the advantage of trading both local and developed market indices such DJIA. Today, the way we have capital and currency controls around individuals, it is not possible to trade an FTSE or DJIA or S&P 500 futures contracts. Sebi has allowed market making for equity derivatives. Will this help in bringing liquidity to new products, or an exchange like BSE which is trying to make its derivatives segment liquid? In many markets, globally, new instruments or new contracts are introduced when a set of market makers are already in place. It is almost like one of the prerequisites that the exchanges put in place before they actually bring new contracts on their platforms.
There is a reason for that. Market makers, for an incentive, provide volume in a new contract which essentially fulfils the same self-fulfilling prophesy of liquidity begets liquidity. Looking at the experience of the international markets, I think it is a good step.
We have seen only a few brokers using smart order routing so far. Are there any particular reasons behind it? I think it is related to the fact that vendor applications need to be ready with this functionality. So, if an exchange-approved vendor provides this facility, the popularity of smart order routing should grow. Then, the onus is on the broker or the client to utilise such a facility. And, of course, the way the application is written is also important. The algorithm has to keep checking continuously for the best price venue.