Sebi allows exchanges to offer 5-year index options

The move will help investors take long-term calls.

Stock market regulator Securities & Exchange Board of India (Sebi) has widened the scope of index-based options by allowing exchanges to offer option contracts based on Sensex and Nifty with a tenure of up to five years. In January, 2008, Sebi had extended the period to three years.

The share of index-based options in the total derivatives volumes has risen from around 10 per cent three years ago to 45 per cent in 2009-10 on the National Stock Exchange (NSE). This year, the share has gone past 50 per cent. Analysts attribute this to volatility and the fact that options are a better tool to hedge risks than futures contracts.

“The move will widen the market. However, at the moment, only a few negotiated deals are happening in the long-dated options market. It will be a facility for investors with a long-term view who want to hedge their positions or take a long-term call,” said Edelweiss Securities Head (Quantitative Research) Yogesh Radke.

At present, short-end contracts dominate the derivatives markets and account for around 90 per cent trades on NSE. “The move may drive over-the-counter (OTC) market volumes back to the exchange,” added Radke. Other market players also welcomed the move and said it would bring more transparency.

OTC options contracts are negotiated outside the exchange and are private deals between parties. These will be a boon for institutional investors such as pension funds and insurance companies which have taken bets on the market and want to reduce risk, according to a stock exchange executive. He added liquidity in such products would be enhanced only when such institutions were encouraged to participate in the segment.

Sebi said exchanges could launch such contracts provided there were eight semi-annual contracts maturing in June or December. In addition, three monthly and quarterly contracts that expire in March, June, September or December have to be offered. The exchanges will also have to put in place a risk management framework for these contracts.

The Sebi board had approved the introduction of such contracts on March 6 this year. The decision was taken following a proposal by the derivatives market review committee.

“The growth in turnover of long-dated options is greater than that of short-dated options. With the market having gained sufficient experience in longer tenure options, it is recommended that options with tenures of up to five years may be considered for introduction,” said the committee report.