Players Jittery Over Derivatives Trading

The introduction of any new trading instrument in the market brings along with it fear and anxiety among the market players. With the introduction of derivatives round the corner, the Indian capital market players are at present undergoing a similar experience. But how valid and justified is this fear, and what measures is the regulator taking to clear the air of confusion which is surrounding the system.

The Sebi appointed committee is all set to frame the regulations for derivatives trading in the country. In the last meeting, the committee members discussed the broad guidelines within which the norms will be framed.

 

One of the crucial areas which the regulator is taking a closer look at is the margin system that should be in place. The margin systems have been accepted as the foundation through which the clearing house guarantees the trades on a futures market. Thus it is all the more important why a stricter margin system should be adopted before derivatives trading is introduced.

The market players fear that the stock markets could witness wide fluctuations if the derivatives are introduced in the Indian market. However, according to statistics made available by some of the committee members, it goes on to show that this is not the case. In fact, after the introduction of on-line trading the Indian stock markets have been less volatile. Also the stock market has remained less volatile after the trading on Nifty commenced. A note prepared by Dr Ajay Shah and Susan Thomas of the Indira Gandhi Institute for Development Research speaks of the margin system which is prevalent worldwide. At the futures market, two types of margin systems work. An initial margin is charged which is based on the position taken by the broker. In India, since the banking system is unable to swiftly move funds, an advance payment of the initial amount is made.

This apart, a net profit or loss on position is paid out to or in by the member on the very same day, in the form of daily mark-to-market margins (MTM). The logic here is that a large loss, when accumulated over several days, generates a temptation to default at settlement. To prevent this from happening, the loss of each day is paid up on that day itself. The member will not default on the MTM payments as long as the one-day loss is smaller than the initial margin.

During the recent meeting of the derivatives committee, the members opined that initial margin will be affected by the volatility in the market. Thus members insisted on imposing a margin on the actual position taken by an individual. For example, if a person has a position with 100 per cent of exposure in X scrip, then this is a highly risky position.

The level of initial margin required here would be quite large. If, instead, a person has a well spread out position with positions spread over numerous securities, then the risk is lower because the person has a diversified portfolio. Thus in this case, the worst one-day loss scenario becomes less volatile and therefore the level of the initial margin becomes less.