Friday, July 30, 2010

Trading of Options in Currency Derivatives

SEBI has given permission to exchanges to start trading of options on currency derivatives. Now it depends on the Exchanges the timing of introduction of products.

It is good on the part of RBI and SEBI to introduced  Options in currency segment, It will definitely boost the volumes and it will have many ramifications in the market.

a) It will boost volumes and opportunities in currency market.
b) Price discovery process of Exchange rate will be more smooth
c) Forex market in India will become more transparent  and huge volumes will move from OTC market to Derivatives market
d) It will give corporates a finer price to hedge.
e) Banks will be spared from allegation of Mis - Selling as corporates would be counter party to Exchange.
f) There will be more arbitrage opportunities
g) It will give opportunity to Importers and exporters to hedge their forex exposure
h) Indian Traders taking position in multi markets and multi products will find it easy to hedge their exposure in such market instead of OTC market.

The Salient features of the introduction of Options are

a) The option would be introduced on USD- INR only (As of now the permission is given to introduce options on American dollars only)
b) The options will be European options.
c) Options will be available in 3 serial monthly and 3 quarterly contracts
d) There will be at least 7 strikes (3-1-3) in each calendar month
e) The Options would be cash settled
f) The Final settlement price will be RBI reference rate.
g) Margins would be SPAN.
h) There will be margin benefit on calendar spread.

The mechanics are same as used on CDX market but we may need some clarity on certain issues
a) Would the margin be calculated on portfolio of (Futures and options both together) ?
b) There need to be clarity on issue of Stamp duty which is imposed in some states

It is a good move and we can expect to see trading in next 3 months

Monday, July 26, 2010

Sponsored ADR of Tata Motors Differential Voting Rights (DVR)

Sponsored ADR refers to issue of ADR, but not by the company but by its share holders (may be promoters). The proceeds of the sale of ADR goes to its shareholders who have tendered share in sponsored ADR. Also if the Tendering of shares are more than issue size, the shares are accepted on pro-rata basis.

Taking from our last blog on DVR ON 14th April, we know that as of now 3 companies have issued DVR (Tata Motors, Pantaloon Retail & Gujarat NRE Coke). They are traded in the range of 25% to 40 % discount to equity price. Such huge discount in price is uncalled for and such steep discount should evaporate in long run.

Tata Motors is exploring the option of issuing sponsored ADR for its DVR, Internationally discount on DVR is not more than 20 % and as low as 5 %. Tata may be intending to sell part of its holding in such sponsored ADR. It is a right move for Tatas to sell their stake as they will get better price and there will be no impact in its stock price.

But I doubt about the pricing of the DVR, ADR may at the best be able to command 15% discount to its stock price. Looking at the returns from current price there is at the most 10% to 12% to be made from this price.

Infosys have done a successful Sponsored ADR, but in their case, the scenario was that ADR was already quoting at huge premium and there was huge appetite for Infosys stock, The returns were simple to calculate.

Tatas may be successful in selling their stake but there is no big money left on the table to be made.for  retail  Investors or Traders. Let us understand the scenarios.

 a) If such exercise is started it will take at least 6 months to materialise, (Getting the Book Runners, getting statutory permission in both countries, Notice to Investor, Placement with Clients and then distribution of Funds)

b) There will be cost of carry for such period.

c) There is probability of price going up as well as down, (Upside looks blink, Downside as Tata Motor is also looking for issue of Rights and Placements)

d)  Hedging the price risk is concern as Futures price of TELCO is known to move between Backwardation and Contagion.

e) Till that time you may be exposed to Exchange rate risk also.

 f) 15% Discount to spot price of TELCO is a best case Scenario, there can be steeper discount.

Current price of Telco is around 830/- and Hypothetically if they are able to place the DVR at 15 % discount the Price would be 705/-. Current DVR price is more than Rs 600/- . So there is 100 Rs on the table. but if we consider the cost of carry for 6 months the Interest cost would be Rs 35/-. That apart there will be Exchange rate risk and there can be more downside if Rollover is done in backwardation.

There is also no antecedence in India about corporate announcement in such DVR, Take a case If Tata comes with right of TELCO shares in futures, Would DVR holder be allowed to participate and How would they be allowed to participate. Such things do not have antecedence which will lead to bigger discount on DVR till such things are sorted out.

Overall, It is not worthy to Invest in Tata DVR with a view to sell in Sponsored ADR, but if you are bullish on TELCO , Yes, it is a good bet as Downside would be lesser and upside would be more in percentage terms.

Thursday, July 22, 2010

SEBI guidelines on Pre opening session

Further to my previous blog on Pre-opening session, there are few point to note from SEBI guidelines.

a) The post closing session will start at 9.00 am and the time up to which order can be put is between 9.07  to 9.08 am. The pre-opening session will close randomly anytime between 7.07 and 7.08am. This is good tools to implement as most people will wait till last movement to put their order as they may not want to disclose their appetite to market, there will also be probability of price manipulation in pre - opening session by putting orders at last movement. Such move of  randomly opening market any time by SEBI will put rest to such practices by market players as they will have to decide between disclosing order to market ( if market opens late) or wait till last movement and risk that order do no go through.

b) SEBI has disallowed disclosed orders in pre opening session.

c) There is no clarity on unexecuted market order, as to what will happen to such orders wilt the start of normal market. Will such unexecuted market order would complete its market order will the opening of normal market or Market order will become Limit orders , Also if such orders are limit orders what would be the limit price.

d) SEBI has said Pre opening session will start from 9.00 to 9.15. But there is no clarity on stocks which are not there in pre - opening session, when will they open ? would it be 9.15  or at 9.00 o clock.

Also what about the opening time of derivatives market ? would it be 9.15  or 9.00.

Monday, July 19, 2010

Introduction of Call Aution for Opening price

As of now Opening prices in Indian Market is calculated as first trade on the exchange. The Exchange is unbiased about the price at which it is traded nor it is unbiased about the trade quantity. The opening price calculated necessarily does not denote the fair price because

a) The opening price can be a fair opening price or it can be an outlier on either side.
b) The quantity traded on opening price is immaterial i.e it can be of 1 share or it can be a stake it the company.
c) Such opening price do not give fair idea about the opening price and there is huge volatility at the open.
d) Many players do not consider opening price as price to reckon as it is just one trade.

Theoretically opening price should reflect the new price which is a consensus price after taking into account all the overnight Informational change and Liquidity needs (Fama). Opening price should be able to clear all accumulated overnight market orders and limit orders which are at or above discovered opening price for buying and limit orders which are at or below discovered opening price for selling.

Such opening price is a good price to read and more reliable. Also it will give better perception about the market. Also equilibrium opening price (As referred by SEBI) may have less volatility and will pass the test of reliability.

The answer to such theoretical opening price is call auction for opening price (commonly called as Pre opening session). SEBI and Exchanges have agreed to start pre - opening session which is a welcome move. This will reduce volatility at the open and also make opening price readable. Such problem will definitely reduce the problem of outliers.

The Salient feature of such Pre-opening session will be as follows
a) All market orders and limit order coming in computation of Opening price will be executed at a single price.
b) It will definitely be a better price to read.
c) It will reduce volatility at the open
d) It will give better signals about the market.
e) It will help in interpretation of Informational change which will reduce noise trading (Fama) at the open.
f) Retail Investors can rely on discovered opening price.

We also need Closing call auction to discover Closing price, which is a long way to go(As Closing price is now calculated as VWAP price). I guess to bring Call closing auction will be difficult in near future as Derivative price discovery is done on closing price and till they are stock settled that wont be tweaked, but at least we have Call auction for opening session.

There was Pre opening session and closing session in India before 12 years on NSE, but it was done away with. (I guess the problem was with price discovery algorithm and lately because of VWAP price at close).I hope we won't face same problems.
Also Recent guidelines on Call auction says that Price discovery process will give priority to Limit Orders and than to market orders. Logically it should be priority to market orders(ATO : At the open) and the to limit orders. I am sure SEBI and Exchange has reason behind this.

I welcome your critical comments and suggestions

Sunday, July 18, 2010

Listing of NSE Nifty of CME

NSE had entered in pact with CME to list Nifty futures on CME and NSE can list futures on DJIA and S&P 500. CME is about to list NSE nifty and start trading on it from 17th July, 2010.

The Salient features of Listing are

a) Foreign Investors and NRI can take position on Nifty using CME platform.
b) It would mean you can trade on Nifty for about 23 hours in a day.
c) The listed NIFTY will be Dollar denominated, hence Foreign Investors need not hedge Rupee Exposure.
d) The Contract size of trading is about 10500 $ and 52500 $. (5 lakhs and 25 Lakhs)
e) The contract size of SGX nifty is also the same as the size on Lower denomination value futures on CME.
f) You can offset CME position on SGX and vice versa. It means the trader can take position in SGX and when SGX is closed he can simply close the position on CME.
g) There is no transaction charge on Nifty Futures on CME up to December, 2010.
h) Many FII and Hedge funds and unregulated entities need not register itself in India and can take position on Nifty.
i) The will be more arbitrage opportunities to global investors as same product is listed in different geographies.
j) They don’t have to pay STT in India which is a major transaction cost in Nifty trades done on NSE.
k) SGX has already signed a contract with NSE to provide Nifty Options, Hence Nifty option will also be traded globally.

Is there any concern of worry?
a) Price discovery will be better if the product is globalised. Nifty will also be looked upon as investment vehicle if there is sufficient interest, Volumes and Open Interest from other geographies.
b) Global Player can trade in Nifty anytime
c) I also perceive that combined Nifty volumes of all geographies will increase but the share of nifty trading in Indian Bourse will fall not only in percentile terms but also in Absolute terms. Because global player will prefer trading in SGX and CME as it will have lesser transaction cost and No STT and No Rupee Exposure.
d) Are many Indian Players equipped and have necessary Logistics and Infrastructure to trade in Global Markets. I guess the answer is No; Most of the Indian Brokerages, Banks and Prop Desk are not equipped. Nor do they possess the required Skill set also they are miniscule in size on global scale.  Also Indian Laws are tough for allow Indian Companies and Brokers to trade on Global Exchanges.
e) There is nothing in store for General Investor as he was always a price taker, but we will have to see Lead-Lag behavior of Nifty between Indian Exchange and Foreign Bourse.
f) 40% of Volume on NSE derivatives is for Nifty Options. As and when options will be traded on SGX we may see big shift in open Interests.

Will NSE lose its Market Share?
Yes NSE will lose volume to Foreign Bourse, but they will compensate fall in Transaction charges with huge license fee and charges from Listing of DJIA and S & P 500.

What will government lose?
Definitely STT, huge STT will be lost by government with shift in volumes, but Government may take solace in Lesser Tax litigation and less entry of unregulated entities.

Friday, July 9, 2010

Introduction of Physical Settlement in Derivatives Segment

SEBI chairman yesterday came and said about the introduction of Physical settlement in Derivatives markets in India. It is a welcome move for the market.

Such move will change the paradigm of Trading and Arbitrage and the players will have to get accustomed to new settlement procedure.

It needs to be seen as to how SEBI comes up with the guidelines on Physical settlement because Settlement of Derivatives segment is done by Clearing members and not by trading members, whereas All brokers are also effectively clearing members of the exchange. What about Professional Clearing members ? Does it mean that SEBI will allowing transferring Trading members position on Brokers Capital market books/ Custodian on Settlement days ? What about exercise of American Options ?

Also Will SEBI give opportunity to player to close trades after the assignment of options ?

What About STT ? What rate would that be charged ?

It will help arbitrageurs to not concentrate on squaring of the position but can concentrate on creating new positions. I guess spreads will come down and backwardation will not be high.

I hope new rules not only help institutional players but are Investors friendly

Tuesday, July 6, 2010

Merger of Samruddhi Cement with Ultratech Cement

Honourable high court of Mumbai & Gujarat have given their permission of merger between Ultratech Cement and Samruddhi Cement. Samruddhi cement was recently de-merged from Grasim for pure cement play and Samruddhi is further merged with Ultratech cement (which also belongs to Birla group) for consolidation of cement business.

Since courts have given permission for merger, The ex date of merger should be announced in few days. The merger ration is 4:7 ie 4 shares of Ultratech cement for every 7 shares of Samruddhi cement.

There lies arbitrage opportunity in the merger process. Since samruddhi will be delisted as it will be merger with Ultratech cement, you can sell middle month and far month options. also there lies opportunity in carry trades.

Buy Samruddhi cement (CMP Rs 476/- * 7 shares)           3332/-
Sell Ultracemco futures (CMP Rs 853/- * 4 shares)           3412/-

Net gain                                                                                80/-

The amt will be released before the expiry of august contract (Maybe the price discovery will be happen before Ex date). there fore the returns on Investments will be 2.5 % for 1 months .