Options In Future: Zilch

As if the Ketan Parekh crisis was not enough!" explodes a stockbroker, "we have now been dealt with another body blow." And this time around too, the watchdog Securities and Exchange Board of India (sebi) is to blame. By banning badla (or carry-forward, the age-old margin trading system on Indian exchanges) from July, sebi thought it would help restore investor confidence as well as business. But exactly the opposite has happened. Volumes have crashed, brokers are switching off their terminals in panic, the Sensex is trying its best to float and the government, deep in the US-64 mess, is facing a wall.

Why has the ban on badla hit the markets so badly? On average, only about 10 to 20 per cent of the share transactions result in deliveries. The rest are carry-forwarded. As a result, since July 2, volumes have dipped by nearly 90 per cent over last year. From an average of Rs 12,000 crore a day last year, trade volumes are down to less than Rs 2,000 crore. In the specified share section, volumes have slumped from Rs 14,000 crore in February to Rs 800-900 crore now. Says Sudhir Joshi, president, The Delhi Stock Exchange Association: "The ban has killed the market, we are helpless as we can do very little for the broker."

Brokers see sebi's decision to do away with badla as a knee-jerk reaction to the irregularities in the stockmarket. Even retail and bulk investors are in a jam. "Business as well as investment is suffering. The ordinary investor today can't encash his shares. It is difficult to get the right price since liquidity has gone out of the market," adds Joshi.

And unless liquidity returns to the market, there is very little chance of the market moving upward. Add to it the US-64 fiasco and the finance ministry seems in dire need of a bailout. With the Unit Trust of India (uti) gearing to unload its US-64 holdings, the market may touch a new floor. And that's exactly what the government doesn't want right now: for uti or for the economy, it badly needs a rising stockmarket.

Why was badla the brokers' darling? Partly tradition but mostly because of the great convenience it offered brokers to work the system. Badla has been replaced by the rolling settlement or the T+5 system. Which means, if you buy a share on Monday, you pay for it through your broker on Tuesday and the share is delivered to you on Friday or latest next Monday. So the share must be delivered on the fifth day of the transaction.

Under the badla system, if you bought a share on Monday, you had till Friday to pay for it or you could carry the transaction forward by paying only the margin, which is the difference between the price at which you bought it and the price of the share on Friday. In this way, the deal could be carried forward up to 90 days without actual delivery of shares taking place in that entire period. Cool, wasn't it?

It's surely a not-so-hot time now. At the Delhi Stock Exchange, for instance, volumes are down from Rs 1,000 crore a day in January 2000 to just Rs 15-20 crore in July 2001! No wonder Joshi thinks badla was a "beautiful and unique system". Even analysts tend to agree. According to Sanjay Dutt, director, Quantum Securities, there was nothing wrong with badla per se. "Badla as an instrument is not the problem, the problem is implementation and surveillance at the exchange level."

While all agree that a margin trading system is necessary for any robust market, the problem is when surveillance becomes lax.What was happening in the market was that due to different settlement dates in different exchanges, people kept shifting positions from one exchange to another. Take the case of the Calcutta Stock Exchange, which has gone virtually bankrupt; there was a parallel badla market operating there. "Didn't sebi know of this grey market? Why did they not stop that? Banning badla is not the solution," says an agitated broker.

Another issue which led to sebi banning all deferral products was the vyaj badla scam that many brokers say has been swept under the carpet and could be worth Rs 700-800 crore. This is operated with the help of private financiers who give brokers money to play the margins game. But many brokers, instead of putting this money into the system, used it for the grey market.

Dutt feels third-party finance is necessary for margin trading and banks and fiis ought to be allowed to lend to the market. "Let the banks decide if they want to take the extra risk. Already, private and foreign banks lend against shares. In order to have competitive lending rates and more transparency, we must have institutional lending/financing in the equity markets," he adds.

But sebi feels that since it has launched a new product—futures and options—the loss of badla will not be felt. Says a senior official: "The cash (delivery) market and futures market get mixed up in badla and that creates a problem. Therefore it is best to have two separate products."

So today the investor has two clear routes, the cash market or the futures and options market. Trading in the latter has started only this month and is yet to catch on. Since it's early days, brokers and investors alike are confused about how the system works. They also feel it's comparing oranges with lemons.

This is how the futures and options market works. In futures trading, you can only speculate on the nse index. And on the last Thursday of every month, the futures contract expires and if you are buying a futures contract you pay up the margin, which is generally 11 per cent of the current index. The options market is a more complex contract—it works both in the case of shares and index and is also settled on the last Thursday of every month. Individual scrips—there are at present only 31 in the options market—have a separate option price. The system works somewhat like an insurance premium contract.

Options also have limited penetration. Today, only two exchanges—the bse and nse—trade in derivatives (or futures and options). The rest need to invest heavily (about Rs 5-10 crore) in new software as well as in educating brokers and investors before they can join. Also, the new system puts Indian operators at a disadvantage against fiis with their greater experience in the stockmarkets of the developed world.

Volumes so far have been limited in the derivative market, about Rs 100-150 crore. The dse has come to an agreement with the bse for the options market where their brokers will be given limited trading member status and will be allowed to trade in options till they get their own act in place. "We will wait for another two to three years, before we invest in software because it will take that much time for the derivatives market to pick up," says Joshi.

Despite brokers hitting the panic button, this time around sebi is unlikely to heed them as the new futures and options system is already in place. "Futures and options is a superior product but along with it we need some form of a margin lending system as is prevalent in the developed equity markets overseas," says Dutt.Also, many analysts feel that the attitude towards stock trading has to change. The government must accept that speculation is inherent in any stockmarket and that there is nothing wrong in it if accompanied with surveillance.

"sebi's job is surveillance alone, it can't decide for the consumer what's good or bad for him. Have different products in the market and leave it to the consumer to pick," says a dse member. Steps like banning badla are driven more by political rhetoric than investor concern, fume brokers. This time, the government seems to have painted itself into a rather tight corner.