Stock futures make their debut

By C. R. L. Narasimhan

Indian stock exchanges took a major step forward on Friday last with the introduction of single stock futures on 31 actively traded stocks. Stock futures such as options are called derivative instruments, because their value is derived from an underlying asset, say a currency, shares, a stock index (the last two relate to the capital market), agricultural commodities, precious metals such as gold. (Enron, the energy major now in the news for all the wrong both here and in America is a pioneer in enlarging derivatives trading to things such as bandwidth).

India has had a tradition of forward trading in agricultural commodities but it was only recently its application to either the capital market or the foreign exchange market was considered. In the forex market, the relative lack of integration with the outside world and the exchange control regulations here are impediments.

The stock markets were not ready for them for at least two reasons: the age-old badla system (an uniquely Indian innovation) and permitted carry-forward of stock market positions. Though at various times, the badla system was blamed for most of the ills and was actually banned before it was immensely popular among the market intermediaries such as brokers. Finally, when badla had to finally go in the face of unrelenting governmental and regulatory pressure, liquidity in the market dried. The introduction of rolling settlements also contributed to a shortage of volumes and liquidity. A second reason as to why derivatives could not be introduced earlier, of course, is the absence of investor education which alone will put these products in the domain of common investors' comprehension. It is obvious that the stock market derivatives will succeed if only they bring in liquidity and vibrancy to the present lacklustre market. All classes of investors should be enabled to participate for that to happen.

Derivatives in the capital market have, therefore, made their advent quite recently in India, first with the index based futures on the two principal exchanges, the Bombya Stock Exchange and the National Stock Exchange followed by option contracts. If Friday's favourable reaction is anything to go by, the stock specific futures will win hands down in the popularity chart. (Actually all the derivative instruments have a role and are often used in conjunction with one another).

It may be early days still but stock market experts say that the stock futures will succeed because they resemble the badla in many ways. Like the badla, they fit into the Indian stock market ethos which is principally grounded on trading. In one respect they score over the badla. Stock futures are issued as contracts for three months. The earlier carry forward extended to one settlement period of one week.

The other advantages are low margin requirements. Because an investor can leverage his funds over many contracts volumes in the market will go up. Liquidity in the stock market will further get a boost because arbitrage between the cash and futures market will be possible. On the minus side, there is a feeling that the popularity of the instruments - confined to 31 specific stocks - will further polarise the stock market trades between liquid and illiquid stocks. Second, greater investor awareness is needed. For both, the stock market reform including investor education has to be carried forward.

The 31 companies on whose stocks future contracts can be bought or sold include ACC, Bajaj Auto, BPCL, BHEL, BSES, Cipla, Digital Equipment (I), Dr. Reddy's Laboratories, Grasim Industries, Gujarat Ambuja Cement, Hindustan Lever, HPCL, Hindalco Industries, HDFC, ICICI, Infosys Technologies, ITC, Larsen & Toubro, Mahindra & Mahindra, MTNL, Ranbaxy Laboratories, Reliance Petroleum, Reliance Industries, Satyam Computer Services, State Bank of India, Sterlite Optical Technology, Telco, Tata Power, Tisco, Tata Tea, and Videsh Sanchar Nigam.

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Section  : Business
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