Traders burn their fingers on Tata Motors DVR futures bets

Holders of DVR category of shares enjoy limited voting rights but entitled to 5% higher dividend than ordinary shares

A popular trading strategy involving futures contracts of Tata Motors and Tata Motors Differential Voting Rights (DVR) has gone sour.

Traders, mostly the well-heeled, are sitting on losses in this trade after Tata Motors DVR futures weakened against broader market expectations, amid speculation that some large investors were selling Tata Motors DVR shares.

Holders of the DVR category of shares enjoy limited voting rights but are entitled to five per cent higher dividend than on ordinary scrip. Globally, DVR shares trade at a discount to their ordinary shares. In the case of Tata Motors, its DVR shares have been trading at Rs 130-160 below the ordinary shares, a difference exploited well by savvy traders through pair trades. This is a strategy involving simultaneous sale and purchase of two stocks or futures in the same sector, on expectations of price convergence.  

In the Tata Motors-Tata Motors  DVR pair trade, traders simultaneously sell futures of Tata Motors  and buy futures of Tata Motors DVR or vice versa, depending on the price levels. Last month, they sold Tata Motors futures and bought Tata Motors DVR futures, on hopes that the price gap between the two would narrow. However, due to a decline in the Tata Motors DVR, their bets have gone awry. Tata Motors futures, which traded at Rs 138 above Tata Motors  DVR futures on June 3, are trading at a premium of Rs 160. Traders are anticipating the gap between the two futures contracts to shrink to possibly Rs 115-120.

“Traders expected the value spread to rise because it was at the lower end of the band of 50-60 per cent at the time these trades were initiated,” said Siddarth Bhamre, head-derivatives, Angel Broking. Value spread is DVR by ordinary shares, multiplied by 100. Traders expected the spread to rise from 50 per cent to around 60 per cent, which would have helped them clock profits. However, the spread has fallen to 45 per cent, resulting in the losses. “Traders are bearing MTM (mark-to-market, meaning writing down the assets based on current values) losses of  Rs 50,000 for each lot of Tata Motors DVR long and Tata Motors short,” said Shashank Mehta, derivatives strategist, Shah Investors Home.

Analysts said the extent of losses had even prompted many traders to continue with their loss-making bets, on hopes that a convergence in their values would help them reduce the damages. But, brokers are pessimistic about the prospects of Tata Motors DVR shares, which have fallen sharper than Tata Motors ordinary shares since early June.

Mehta said traders could hedge their losses in the trade by purchasing put options of Tata Motors DVR, to hedge their futures positions. “To limit the extent of MTM losses, buying ATM (at-the-money) put options of Tata Motors DVR would be prudent,” he said.