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A shot for the markets

SEBI has given its nod for new derivative products. What does it mean for you?

Clifford Alvares        Print Edition: December 16, 2007

Last month, SEBI approved the launch of a wide range of new derivative products aimed at increasing the market’s depth and providing investors a slew of riskreducing products that will help create a healthy and vibrant domestic market. The new products are based on the recommendations of a SEBI Committee on Derivatives headed by M. Rammohan Rao.

Among the products mooted is mini-contracts on options, which will allow small investors to participate in the stock market. As of now, the size of an options contract is about Rs 2 lakh, but if that comes down to around Rs 50,000, it will allow small investors to hedge their positions in the market. Moreover, other investors will be able to hedge their positions more effectively up to the precise amount of exposure.

For example, an investor with a portfolio of Rs 3 lakh was able to cover only about two-thirds of his investments with options. With smaller contracts, an investor will now be able to hedge 100 per cent of his portfolio and, thus, have a perfect hedge.

On the anvil

New derivative products will give you a better handle on the markets.

  • Mini-contracts: In the options market, currently the minimum transaction allowed is to the tune of Rs 2 lakh, which has kept many small investors away. If the contract size comes down to Rs 50,000, small investors can participate better in the options market and hedge their positions effectively.
  • Longer options: Currently, the options are of a maxi mum of three months duration. Longer option tenures will help increase the depth of the capital market and allow investors to hedge for longer periods.
  • Volatility index: This index will help investors measure the volatility of a particular index. The calculations of this index is complex as it measures the difference in prices of put and call options, but a higher index sug gests that the market is going to get more volatile going forward.
Besides, longer-tenure options, unavailable in the market, will soon be introduced in the stock markets. Now, a maximum of three-month contracts are allowed, but once the longer contracts are introduced, long-term investors can hedge their longer positions. This will also help provide more liquidity and depth to the stock market.

Another key product SEBI has cleared is a volatility index, which will measure the implied volatility of both put and call options and calculate a value. A higher value will suggest more volatility, and, therefore, an increase in the options premiums. This suggests that the writer is unsure about the market and is, therefore, charging higher premiums.

Fund houses have welcomed the initiative. Says Sanjiv Shah, Executive Director, Benchmark Mutual Fund: “It’s a good move. It will help investors gauge the volatility of the market will be in the near future.” Another product likely to see the light of the day is options on futures, and it will help investors hedge their futures positions.

These products are still in the design stage and it could be a few months before they are ready for launch. Yet, all these new products will provide a wider range of risk mitigation products and create more activity in the Indian markets. The earlier they come, the better.

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