Algo traders shun BSE derivative products in absence of reliable data

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Derivative contracts are high risk-reward instruments that can be used to hedge bets in the equity market.

Trades by HFT firms accounted for 54 percent of the total on the exchange, according to NSE data for December. The NSE handles about 99 percent of all derivative trading in India.

HFT firms – or algo firms in market lingo – use complex algorithms and powerful computers to execute trades at lightning speed. They take very large positions in quick succession to make the most of market movements.

This is where the BSE’s Sensex and Bankex fall short. Since they have hardly any volumes, these traders, even if they want to, will not find a counterparty. That’s in addition to the absence of enough reliable data for back-testing.

Also read: HFTs tighten grip, make a killing on the Street as F&O volumes explode

The strategies employed by these traders are based on back-testing of data of several years. Once a strategy is developed, it is tested to see if it would have been profitable in the past, and if the result is favourable, the strategy is codified before running it in the live market.

“Most of the fulltime traders rely on back-testing and don’t want to start trading some random asset class,” said Ankush Bajaj, a Chhattisgarh-based algo trader.

Ironically, the BSE was the first exchange to introduce futures and options (F&O) contracts in India in 2000, days before the NSE came out with its own F&O products. The BSE failed to make much of the early start and the NSE capitalised on its rival’s failure and has never looked back. Now, in its new avatar, the BSE expects it will taste success. However, it is not likely any time soon, investors said.

According to Ajay Garg, managing director of Equirus Capital, a merchant banking firm, once you achieve volumes, it becomes that much harder for someone to replace you, alluding to the NSE’s dominance.

"It is a chicken-and-egg situation. Brokers won't go to the BSE till there are heavy volumes and depth. And, volumes won't come if brokers don't shift," he said.

“The new contracts are interesting, with the new lot size and Friday expiry; this should help bring in some volumes. It’s too early to comment on volumes as these contracts were introduced recently,” a top honcho at a prominent broker said.

Although the BSE has accepted it is too small to be called a competitor in the business and does not plan to fight it out with NSE, its ambitions are apparent.

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Another reason the BSE will find it hard to build volumes, according to investors, is that Sensex and Bankex contracts are not very visible. A Kochi-based trader who was keen to trade these products did not find them with any of his three brokers. Not many brokers, even prominent ones, offer Sensex or Bankex products to clients.

A top broker said it is making front and back office changes to offer the BSE products to clients. The broker did not specify when this will be ready but added that it would be “very soon.”

Also read: We are too small to be seen as competitor in F&O segment, says BSE MD & CEO

The BSE said it was working with brokers on the software and vendor fronts to bring volumes. Sundararaman Ramamurthy, the MD of the BSE, said it will happen in a few months.

The BSE may need to do some convincing to get brokers excited about the new products on offer. A boutique broker said on condition of anonymity that if there were no volumes and customer requirements, there’s no reason to spend money to buy a software licence or run machines.

Ramamurthy told Moneycontrol that he accepted the shortcomings and the failure to make a mark despite being in the market for over two decades. He, however, clarified that the BSE was not looking to incentivise traders to trade in Sensex or Bankex contracts.

The bottom line is that the BSE is not keen on wasting resources with its liquidity enhancement schemes, which were introduced to encourage investors, because they have been an utter failure.

HFT firms will likely give the Sensex and the Bankex contracts a miss, given the lack of volumes and data, few traders, and the difficulty in finding these contracts. Even after the product innovation and relaunch, it appears that the BSE has a tall task to make its presence felt in the derivatives segment.