Stock derivatives trading gains traction among investors

Analysts concerned about excessive leverage in the system

As investors turn more confident about the market, trading in the stock derivatives segment has seen an increase. Analysts say now, investors are willing to take speculative positions on individual stocks through higher leverage, often without adequate hedges in the cash market.

This month, trading in stock futures has increased to 23 per cent of the total future and options (F&O) turnover from 19 per cent in the previous month, according to exchange data. So far this month, the total turnover in the stock derivatives segment stands at Rs 46,452 crore, against Rs 45,820 crore in October and Rs 32,173 crore in January this year.

The uptrend in the market, which has seen benchmark indices rise about 30 per cent this year, has made investors confident enough to increase exposure in the derivatives segment, industry players say. “On the whole, the markets are doing well and market sentiment has turned positive. So, people are thinking ‘for the same amount, why not take larger positional calls in stocks through derivatives than through the cash market segment’,” said Mehraboon Irani, principal and head (PCG), Nirmal Bang Securities.

Traders’ stock-specific bets have seen the National Stock Exchange (NSE) become a world-beater. According to data from the World Federation of Exchanges, in October, the NSE clocked the highest notional turnover in the stock F&O segment; it has been at the top position since January this year. At $134,327, the turnover on the NSE in October is the highest, followed by the Eurex and Bovespa at $98,931 and $90,691, respectively. Trading in stock-based derivatives isn’t very popular in a few developed markets such as the US.

While high net worth investors (HNIs) dominate this category, now, retail investors are also showing interest, industry players say. Besides individual investor participation, a rise in the popularity of arbitrage funds and restriction on the participation of foreign institutional investors in stocks has also led to an increase in activity in the stock derivatives segment, analysts say. Within the stock derivatives segment, the stock futures segment is preferred, they add.

But some analysts believe the rise in trading in stock futures is a concern, as it increases leverage in the system. “It is not a bragging point, but a sign of worry that you are creating excessive leverage in the system. Our markets are far more volatile. If you have greater volatility, which is a function of local factors and international factors, leverage positions in the market aren’t great things to have,” said Amit Rathi, managing director, Anand Rathi Financial Services.

India is one of the few markets which trades in individual stock futures. In developed markets like the US, the leverage permitted in trades is capped. However, in India there are no such restrictions prompting people to take leveraged positions at much higher levels than is deemed safe for investors.

"And in most countries like the US, your leverage ratios are restricted so you cannot borrow more than 50% against a stock. Here people were leveraging with 20% margin down. So, the leverage ratios are far greater," said Rathi.

However, the industry is willing to look the other way as long as the trades generate higher revenues and higher volumes.

"I don't think there is an active voice around this because in the short-term this is counter-productive to brokerages because volumes go down and commissions go down. I think regulators can play a more constructive role in trying to curb this because if you expect industry players to do it, it is unlikely to happen," said an official with a domestic brokerage who did not wish to be named.