Option schemes face Sebi heat

Regulator warns brokerages, wealth managers against making false promises.

A large number of the so-called ‘assured’ or ‘indicative’ return schemes run by leading stock brokers and financial services firms, mainly in the equity derivative segment, have come under the regulatory scanner. For, it appears, investors are being lured into derivative schemes by verbal assurances of returns, something not permitted by the market regulator, the Securities and Exchange Board of India (Sebi).

In the recent past, Sebi and the National Stock Exchange (NSE) have received several complaints against wealth managers or brokers. Complainants say their money was diverted for trading in index options with a promise of a certain fixed return. However, they lost money as the bets went wrong.

These schemes have been under watch after a derivative product, Options Maxima, run by Aditya Birla Finance, lost an estimated Rs 100 crore and went bust last year. Also, losses to the tune of Rs 300 crore came to light in the case of trades (mainly index options) conducted by Citi Group’s now jailed wealth manager, Shivraj Puri, through a couple of brokerage houses.

An official from Sebi said, “In most cases, there is a private arrangement between clients and the sellers of such schemes, so we are issuing warnings to brokerages against luring clients with promises.”

Source, concerns
According to this official, another area of concern was the source of funds, as index option volumes had surged alarmingly in recent times. “This requires following of proper know your customer norms, which is where we will crack the whip if irregularities are found,” added the official.

A fat commission on option trades is the key reason why brokerages are encouraging and inducing clients to dabble in this segment. Most brokers charge a flat fee in the range of Rs 50 to Rs 100 per lot per leg — on each buy and sell transaction — in the options segment. In cases where volumes are high, the cost could be lower. Also, the risk element is relatively less for stock brokers in allowing the clients to trade (especially when buying) in index options. To play in Nifty options, one has to pay just a premium on the strike price. This is as low as 1-1.5 per cent of the price of the asset. However, in the futures segment, the risk for brokers is high, as clients take positions by paying as much as 20-30 per cent margin money and it may become difficult to recover the remaining money during crises.

“Due to high competition, brokers are using higher-margin options trades to enhance their revenues because of high volumes. Sometimes, even the KYC norms are neglected. Retail investors should be cautious, as there are many ‘ifs’ and ‘buts’ attached to such schemes,” said a South Mumbai-based equity advisor.

Not surprisingly, volumes in the options segment have seen a sharp rise. On the NSE, the share of options trading in the overall derivatives segment rose to 72 per cent at the beginning of this year. It has continued at that level. In January 2010, this number was 50 per cent. Of the total option segment turnover, Nifty index options generate 96 per cent of volumes. On an average, around Rs 1 lakh crore worth of equity derivatives are traded daily on NSE. The fact that a majority of the volumes in options trading come from the retail trade and high net worth individuals (HNIs) are a major cause of worry, as they stay away from markets for a long time if they make huge losses once.

“This proves the point that there are a large number of schemes being run by brokers and wealth managers in private arrangement with clients. Such schemes cannot be linked to stocks, as daily indicative bets are placed on the benchmark index,” said the head of an institutional desk.

“Relationship managers of broking firms, who are under pressure to meet targets, are selling these types of derivatives products by verbally promising assured returns,” said the chief executive officer of a domestic broking firm, on condition of anonymity. “Clients also need to be careful and understand the product. They start complaining when they make losses.”