Introduction to Futures and Options Markets in India

MANISH BANSALJeetay InvestmentsEmail: manish.bansal@jeetay.com Phone: +91 98924 86751www.jeetay.com

To lead, one needs to be different and to be different, one needs to innovate strategically, on continuous basis.

2.

Introduction

3.

Great journey of Equity Derivatives

year

Average Daily Turnover in

Rs. crore

2012-13 113140.76

2011-12 125902.54

2010-11 115150.48

2009-10 72392.07

2008-09 45310.63

2007-08 52153.3

2006-07 29543

2005-06 19220

2004-05 10107

2003-04 8388

2002-03 1752

2001-02 410

2000-01 11

Having started in 2000, journey on Equity Derivatives volume growth has been a spectacular one.

Data Source - NSE

4.

Great journey of Commodity Derivatives

Commodity Derivatives, having started in 2003, have shown buoyancy and growth on continuous basis. Volume of other exchanges such as NCDED etc. are in addition to these nos.

YearTurnover in Rs. Crore

2003* 138

2004 93,432

2005 6,23,574

2006 20,25,664

2007 27,29,820

2008 42,84,653

2009 59,56,655

2010 86,96,869

2011 1,49,32,852

2012* 56,98,492

* For part year.

Data Source - MCX

5.

Great journey of Currency Derivatives

Having started in 2008, market has witnessed significant growth in Currency Derivatives volume.

YearTurnover in Rs.

Crore

2008-09* 1,62,272

2009-10 17,82,608

2010-11 34,49,787

2011-12 46,74,989

2012-13* 6,21,990

* For part year.

Data Source - NSE

6.

Product Profile

Products Settlement type Tenor

Equity Derivatives

Futures and options on indices (domestic and international) and stocks

Cash settled Products Majorly 3 months products. Some products are available up to 5 yrs.

Commodity Derivatives

Commodities – Energy, Metals, Bullion, Oil and Seeds, Fiber, Weather etc.

Compulsory delivery; Sellers’ option and Intention matching Products

Up to 1 yr. products

Foreign Exchange

Four currency pairs – USDINR, GBPINR, EURINR and JPYINR.

Cash settled Products in Indian Rs.

up to 1 yr. products

Interest Rates Notional bond Delivery based Products up to 1 yr. products

7.

Product Profile

MTM Circuit filters Position limits

Equity Derivatives Daily Only operational circuit filters

Exist for market, members and clients

Commodity Derivatives

Daily Only operational circuit filters

Exist for members and clients

Foreign Exchange Daily Only operational circuit filters

Exist for members and clients

Interest Rates Daily Only operational circuit filters

Exist for members and clients

8.

Regulatory Snapshot

• Regulatory goal is not to ensure that clients do not incur

loss; But, to ensure that failure of any member does not

affect integrity of the market.

• Adequate risk containment systems in place to avoid

failures:

– Robust on-line Margining System (IM and MTM).

– Exposure limits linked to Liquid Net-worth

– Position limits linked to underlying size and OI - Market

Level, Trading/Clearing Member Level & Client Level

• Separation of clearing and trading activities.

• Compulsory collection of margins from clients.

• Continuous on-line monitoring of client level positions.

9.

Exchange Traded Vs. OTC Products profile

Underlying Exchange Traded OTC

Equity Vibrant market; $20-25 Bio average daily traded volume over last several months; Dominant player is NSE.

Standalone OTC Derivatives don’t have legal support on enforceability. However, products like Equity Linked Debentures exist (access products). Outstanding - $5-7 Bio (Market estimates)

Currencies Vibrant market; $10-15 Bio average daily traded volume over last several months; Dominant players are NSE and MCX.

Very vibrant market for variety of products and tenors. Corporates need to demonstrate the underlying transaction.

Commodities Vibrant market; $15-20 Bio average daily traded volume over last several months; Dominant player are MCX and NCDEX.

Small market. Corporates allowed to hedge their risks. Dominant players are only offshore banks – Citi, DB, MS, Goldman etc. Corporates need to demonstrate the underlying transaction.

Rates Products exist on exchanges, but no volumes.

Very vibrant market for variety of products and tenors. Corporates need to demonstrate the underlying transaction.

Credit Not available CDS just launched (Dec. 2011). Progress to be seen.

10.

OPPORTUNITIES TO CREATE VALUE THROUGH

DERIVATIVES

11.

Esops – An opportunity

• Esops are essentially call options, issued to the

employees.

• Today, either employee can exercise those options after

vesting or let them expire worthless.

• Listing and trading of vested options would help the

employees monetize their options without exercising

them.

• Opportunity:

• Credit the vested options to employees in their Demat account.

• List and trade the vested options on Stock Exchanges.

12.

Rights – An opportunity

• Rights are essentially call options, issued to the existing

shareholders.

• Today, shareholders exercise these options, let them expire

worthless or surrender/transact them in OTC market.

• Listing and trading of rights on Stock Exchanges would help

the shareholders monetize their options much more

efficiently (better liquidity, price discovery and ease) .

• Opportunity:

• Credit rights entitlements (REs) to shareholders in their Demat account.

• List and trade the REs on Stock Exchanges.

13.

Put options & buy back – An opportunity

• Fixed price buy back of shares is essentially a put option,

offered by companies to the existing shareholders.

• Today, shareholders exercise these options or let them expire

worthless. There is no market to transact these options. Based

on exercise or no exercise, process results in non-homogeneous

distribution of values among investors.

• Listing and trading of these options on Stock Exchanges would

help the shareholders monetize their option.

• Opportunity:

• Credit buy back entitlements (BEs) to shareholders in their Demat account.

• List and trade the BEs on Stock Exchanges.

• Companies may also write put warrants to the market

participants (builds confidence + earns money).

14.

Third party Warrants – An opportunity

• A warrant is nothing but an option - may be call or put.

• Institutions may write call options backed by the shares, they own (covered call).

• Institutions may like to buy the put options on the shares, they own.

• Institutions may also write long dated naked options. In this case, their positions may be margined like any other sold position (institution created product and not the exchange created product).

• Warrants may be cash settled or physically settled warrants.

15.

Derivatives Risk Management in OTC

• OTM market has a lot to learn from the exchange environment

on risk management.

• More and more business to move to collateralized basis:

– Margining to make customers much more disciplined

– Margining avoids unhealthy competition among intermediaries

– Margining results in reduction in credit risk and capital charge, which in turn

reduces the threshold minimum return on the trades i.e. Pricing, hopefully,

becomes sharper (better for customers)

– Regulators may like to define minimum margin for all OTC trades

– Opportunity for clearing corporations to take up/serve the OTC trades

16.

Derivatives Risk Management in OTC

• OTC market will eventually outsource credit risk management

function to professional entities (clearing corporations):

– Significant focus on monitoring and control of credit limits.

– Efficient execution of collateral agreement in timely manner - MTM

computation, collateral calls and squaring off of transactions

• Clearing corporations to build competencies /gear up to

handle complicated/structured transactions in the OTC world

(beginning may happen with simple transactions).

• CCIL has already taken several steps in this direction.

Journey is still a very lengthy one.

17.

Become a learning

machine.

Charlie Munger

Concluding remark

Thank you

Please feel free to reach me atManish.bansal@jeetay.com +91 98924 86751