February 23, 2012: Rapid rise in derivative turnover on the BSE is taking everyone by surprise. Overall volume crossed Rs 50,000 crore last week — that is almost half the average daily derivative turnover recorded on the NSE. The question that arises now is whether this increase is sustainable.
BSE introduced derivative trading in June 2000, around the same time as the NSE. But, NSE was able to garner larger share in derivatives as traders already using its nation-wide online terminals easily switched to derivative trading on the same.
Over the years BSE was unable to increase its trading in futures and options despite making various changes such as introducing mid-month expiry, mini-contracts of Sensex and so on. But the game changer for BSE was SEBI giving permission to exchanges to introduce liquidity enhancing schemes to improve liquidity in illiquid securities in June 2011.
SENSEX OPTIONS
BSE introduced its first Liquidity Enhancement Incentive Programme (LEIPS) in September last year. Turnover started ticking higher from then on. Average daily turnover which was Rs 40 crore in September, rose to Rs 258 crore in October. This figure crossed Rs 1,000 crore in November and continued soaring to Rs 3,143 crore by January.
The real impetus, however, came with the introduction of LEIPS III in February. Many changes were brought about in this programme with the most important being its focus on Sensex options. This scheme offered four types of incentives based on trading volume, open interest, quoting obligation and lower transaction fee on premium based turnover.
Trading in Sensex options, especially put options, has increased manifold since the introduction of LEIPS III. There are two ways in which this focus on options has given a fillip to volumes.
One, premium on options is much lower than margin required for trading futures. In other words, options offer greater leverage that in turn tends to increase volume. Options also arrest risk since loss is limited to the option premium and are preferred by savvy traders who wish to put in complex trading strategies. It is, therefore, not surprising that number of contracts traded has grown 16-fold since the beginning of February.
Another way in which options inflate turnover is because of exchanges normally stating notional value of the contract while stating options turnover. This figure is arrived at by considering the strike price of an option. This tends to inflate the volume in value terms greatly. If only the premium paid for the options is considered, the volume traded can shrink by over 90 per cent.
The big bill that the exchange is running up every month will stop it from continuing these liquidity enhancement schemes for too long. Its payout for liquidity enhancer-wise alone for January 2012 was Rs 12 crore and open interest incentive payout was Rs 1.1 crore.
SUSTAINABLE?
While each programme ends after six months, the BSE Web site states, “Also, the programme shall be discontinued as soon as the average trading volume on the Exchange, during the last 60 trading days, reaches one per cent of market capitalization of the underlying.” Since over 95 per cent of the turnover is contributed by Sensex contracts, this limits the extent to which the turnover can grow.
Current market capitalization of Sensex is Rs 30.38 lakh crore. The programme will, therefore, have to end the average turnover gallops beyond Rs 30,000 crore for 60 days.
Reports released by BSE also shows that turnover under these schemes are concentrated in the hands of few market makers. Further category-wise turnover in the BSE derivative segment reveals that the proportion of proprietary trading (trading done by stock brokers) increased sharply and stood at 73 per cent on February 23, implying that the brokers could be putting in the trades to earn the incentive.
VALUABLE ASSET
Having said that, there is no doubt that the Sensex brand is a valuable asset for BSE. It enjoys greater brand recall among overseas investors also.
It is likely that once the turnover in Sensex options sustain above a certain level for a period, institutions wanting to take a bet on overall market direction might want to do it through Sensex futures and options.
