Over-leveraging in the futures market can be dangerous to an investor’s financial health. On the other hand, options allow the same exposure at a relatively lower risk even in turbulent times. The use of options can be very rewarding at turning points in the market where a change of trend is forecast, yet the trade carries a high risk due to increased volatility.
Thus, in theory, the investor can use options to accomplish his financial objectives. However, the reality is that even after seven years of its launch, the options market in India remains very illiquid. Of the 275 stocks for which options are available, investors may actually be able to trade just a handful, maybe 25 stocks. Even in these 25 stocks, executing a trade may not be easy. The situation is no different for index options. Of the many indices for which options are available, options on the Nifty are liquid and offer high volumes. All other indices have negligible trading in options, so investors cannot buy or sell them.
If options are a superior way of hedging risk and are less risky, why were stock futures introduced? The answer to this question lies with Sebi and the NSE. After stock options were introduced in June 2001, brokers and traders started clamouring for more speculative instruments. Sebi and NSE then introduced stock futures, where traders can pay a small margin and gain large leverage. But wasn’t that what options were designed to do in the first place?
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Both options and futures provide leverage. But futures provide more leverage than options and, therefore, the trading community has gravitated towards futures, ignoring options. Since all the traders moved to stock futures, the options market languished for lack of liquidity.
How can we revive the options market and inject liquidity? As a first step, Sebi must abolish the stock futures. India is probably the only country where stock futures are offered to retail investors. In most other countries, these instruments are considered just what they are, weapons of mass wealth destruction, and hence are avoided.
Stock futures are primarily an instrument for speculation. It’s a vicious cycle that needs to be broken. To provide depth to the options market, traders have to be moved from stock futures to options. This will only happen if stock futures are not available.
If Sebi wishes to retain stock futures, it should increase the lot size to ensure that only large institutional investors can trade in them. Right now, some stocks come in lot sizes of 50, which encourages small investors to jump in.
The removal of stock futures will immediately revitalise the nearly dead options market as traders will move to options. While a vibrant options market is a big benefit to individual investors, an incidental benefit of abolishing stock futures will be the protection of lakhs of middle-class households which are dabbling in futures and losing their lives’ savings.
Second, regulators need to create market makers in options. A market maker takes on the responsibility for providing liquidity to the options of a specified stock. He provides two-way quotes, is willing to buy as well as sell, thus bringing liquidity and stability to the stock options market.
— Sudarshan Sukhani, Managing Director, SS Trend Analysis Services
