India’s oldest stock exchange —BSE Ltd — is making a renewed attempt to revive its comatose derivatives segment by bringing back the Sensex and Bankex futures and options (F&O) contracts with reduced lot sizes and different expiry dates.
Managing Director and CEO Sundararaman Ramamurthy announced the relaunch of the two products at a press conference in Mumbai on May 15.
The stock exchange said that the lot size for F&O contracts of the Sensex has been reduced to 10 from 15 earlier. For the Bankex index, the lot size for futures and options contracts has been changed to 15, instead of 20 earlier. Contracts for both the indices will now expire on Fridays, instead of Thursdays earlier. Changes will be effective for its monthly, weekly and long-dated contracts.
BSE’s previous efforts in this direction have come a cropper, and market participants feel the odds are heavily stacked against the exchange this time around too. At present, NSE is a near-monopoly in equity futures and options with an over 99 percent market share.
But there is reason for BSE to be hopeful. The one big change now is that trading in options has risen to a frenzied scale in the last couple of years. That’s because the fundamental purpose of options, which is to mitigate risks, has been turned on its head post-Covid. An overwhelming majority of new traders look at options as an instrument for speculation, something that helps earn the most returns by investing minimum capital.
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The only factor in favour of BSE’s newly launched options products is that the contracts expire on Friday. Market leader NSE’s top weekly option contracts Nifty and Nifty Bank expire on Thursday, Nifty Financial expires on Tuesday, and the recently launched Nifty Midcap Select expires on Wednesday. Nifty Financial initially had a Thursday expiry, but that was later changed to Tuesday, ostensibly to ensure that traders interest was not spread thin across three contracts in a single day.
The move has worked well, with trading volumes in Nifty Financial (Fin Nifty in market parlance) rocketing.
BSE is betting that by keeping a Friday expiry, it can attract traders who are looking to trade options expiring on the same day or looking to play the Monday-Friday settlement cycle. That could work up to a certain extent, but there is always the risk that NSE could shift the expiry of either Nifty Bank or Nifty to Friday at some point, if it senses a threat from BSE’s weekly options.
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Rivalry between the two bourses goes back many decades. BSE old-timers allege that the NSE dispensation under former MD Ravi Narain lobbied hard to ensure that regulatory approvals for BSE were delayed or that rules were interpreted in a way that favoured the NSE.
Back in 2001, BSE had launched its derivatives trading—first index futures and later index options—a few days ahead of NSE. Brokers were required to go through a separate registration to provide derivatives trading services. BSE’s credibility at that point had hit rock bottom in the wake of the 2001 stock market scam with broker Ketan Parekh at the centre of it. The BSE board had been superseded and a professional management appointed in its place was still finding its feet.
The BSE veterans say that registration approvals for BSE members were slow in coming, with the result that most brokers who anyway had dual memberships, started applying for registrations on their NSE memberships. Once NSE took the lead in derivatives, the gap quickly widened to the point where BSE’s presence was negligible.
In 2012-13, BSE introduced the Liquidity Enhancement Incentive Programme (LEIP) to boost volumes in its derivatives segment. At one point, it was almost spending Rs 10 crore a month. But the scheme failed to move the needle for BSE’s derivative segment. In 2016, the bourse scrapped the scheme and after some years, again resumed it, but on a much smaller scale. Last year, the BSE was paying out around Rs 1.5-2.0 crore a month to market markets in the derivative segment.
Effective April, LEIP has been scrapped altogether. That appears a bold gamble on the new management’s part. Because NSE, despite being the market leader, is indirectly incentivising its trading members to drive options trading volumes. Beyond Rs 2,000 crore of monthly turnover in options premium, the exchange transaction charge that trading members have to pay NSE drops by 40 percent.
As this report shows, NSE is estimated to have paid up to Rs 1,000 crore or even more, by way of rebates to its trading members in FY23. Also, NSE has extended the waiver on exchange transaction charge on the its Midcap Select Index till September 30.
To bet that an army of option traders will flock to BSE just because that is the only game in town on a Friday is a big leap of faith. As people in the exchange business know, liquidity can both be a virtuous and a vicious cycle. Liquidity attracts liquidity, and by extension, lack of liquidity will lead to even more illiquidity.
Feverish trading in options contracts is not restricted to India. A similar situation is playing out in the US in zero days-to-expiry (0DTE) options, which as the name suggests, expire on the same day.
If BSE’s options gambit succeeds, it could pave the way for more products as market leader NSE too would be forced to innovate. This would help broaden and deepen India’s equity derivatives market. The BSE may or may not succeed in its latest endeavour.
But it has little choice but to try anyway. Transaction fees from options trading has been the biggest driver of NSE’s revenues in FY23. On the other hand, trading volumes in the cash market—both on the NSE and BSE—have been shrinking. That hurts BSE even more because it is main source of revenues.
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