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The Securities and Exchange Board of India (Sebi) has been constantly working towards making retail investors safe in the stock market. The recent news that it is proposing to raise the minimum contract size for trading in equity derivatives from the existing Rs 2 lakh to Rs 5 lakh and eventually to Rs 10 lakh is good for them.
This is the first time since the introduction of derivatives trading that the limit for the minimum contract size might be tinkered with. Sebi had earlier done away with mini futures and options contracts, to discourage small investors from entering the derivatives segment.
Derivatives are a hedging tool. For instance, an investor with a position in the cash segment can minimise either the market risk or price risk of the underlying stock by taking reverse position in an appropriate futures contract. It is also a leveraging tool, which allows one to take a large position with less capital. For example, one can take a position by paying 10-20 per cent initial margin.
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Notably, in 2012, the market regulator had raised the limit for investment in portfolio management services (PMS) from Rs 5 lakh to Rs 25 lakh. The aim was to keep out small investors from the PMS segment, as it was not as tightly regulated as mutual fund industry. Similarly, the regulator also prescribed a minimum lot size of between Rs 1 lakh and Rs 2 lakh for investment in SME stocks to dissuade uniformed investors from entering. For all its good intentions, the increase in contract size could spell bad news for savvy retail investors. According to estimates, 95 per cent of investors in the F&O segment are retail investors and of this, 80 per cent have a portfolio of less than Rs 10 lakh. “These people will be deprived from hedging their portfolio,” said Siddarth Bhamre, head – equity derivatives at Angel Broking. Investors today can hedge their portfolio against a fall in the market by buying put options or selling out of money call options, he adds.
The increase in contract size will jack up costs which, in turn, could impact liquidity. Let's take an example to understand this. For buying a Rs 2 lakh futures contract at a 10 per cent margin, the investor has to pay Rs 20,000 today. Depending on whether the contract size is increased to Rs 5 lakh or Rs 10 lakh, the investor will have to pay Rs 50,000 or Rs 1 lakh upfront. In options, if you are paying a premium of Rs 5 for a lot size of 500, you pay Rs 2,500 today. Going forward, the investor will have to shell out Rs 5,000 or Rs 12,500 based on the new contract size.
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“Liquidity will suffer, particularly if the minimum contract value is increased five times to Rs 10 lakh. Also, since the investors will have to pay more, the chances of losing more money are also higher,” said Nithin Kamath, chief executive officer, Zerodha, a discount broker.
Experts believe that despite the new restrictions, retail investors might figure out a way to beat the system. For example, there might be an increase in off-market trades or informal arrangements between investors and brokers. “The broker may trade in the investor's name, and then informally settle the gains or loss, off market with the investor,” said Kejriwal.
Also, investors may avoid the high costs by migrating from futures to options trading since more money is required in the former. “Instead of putting up Rs 2 lakh as margin for futures to buy, say, a stock future at Rs 100 and lot size of 10,000, investors might decide to buy an out-of-the-money call option at a strike price of 105 trading at Rs 2 since they will have to pay only Rs 20,000 (10,000 x Rs 2),” said Kamath.
While this minimises cost, Kamath has a word of caution: “While the risk in buying options is limited to the premium paid, the chances of losing money are much higher than in the futures segment, where the risk is unlimited.”
