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Moneycontrol Pro Panorama | The massive leverage at the heart of the Indian stock market

In today's edition of Moneycontrol Pro Panorama: Can US mediation help Israel-Palestine conflict, Nithari acquittals raise harsh questions, businesses anticipate the big fat wedding season, testing times for the Indian rupee, and more

October 18, 2023 / 18:09 IST
Despite various restrictions and warnings by the market regulator, the derivative segment continues to grow.

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Are Indian market structures fragile? A note by Axis Mutual Fund CIO Ashish Gupta points out what SEBI had said earlier: Indian markets are heavily tilted towards options trading.

Gupta's note, however, highlights some interesting data points. Here are some that highlight derivative trading is both interesting and dangerous.

Equity derivatives account for a staggering 99.6 percent of market volumes, totalling over $4.3 trillion per day. Index options constitute 99 percent of derivative volumes within derivatives, but 95 percent of these volumes are in weekly options.

The reason for the attraction of weekly options is the leverage they offer. On an expiry day, an index option's effective leverage is 500x. In other words, an option buyer can buy an option contract for Rs 2,000 and get exposure to Rs 10 lakh of the underlying index. The average exposure to such options is only 30 minutes, highlighting the speculative nature of the product.

Because of the shorter time for expiry, weekly options are cheaper than monthly contracts, giving a buyer higher exposure. Generally, Nifty's at-the-money (ATM) weekly contract is available at 40 percent of the cost of a monthly contract for the same notional value exposure. The effective leverage increases from 56x to 126x, thus making the weekly option more attractive to capture any short-term move.

The game becomes interesting on expiry day when exchanges reduce the margin because of the low time to expiry, offering the trader a leverage of 420x.

No wonder there are very high volumes on expiry days. NSE offers four different weekly expiries for its four indices to milk this opportunity. On the fifth day, a trader can try his hand at trading Sensex, which expires on Friday.

Options traders are largely intraday traders, which can be gauged from the open interest data, which at the end of the day is only one percent of the daily traded volumes, indicating that only 1 out of 100 contracts is carried forward to the next day.

The highly speculative structure of the market gets another element of risk when we look at the trader's risk profile. The average age of a trader with a digital discount broker account is 29 years, similar to 31 years for online gaming companies. Half of the new customer additions are below 25. Most of these traders have not seen a bear market crash like the financial meltdown or the COVID-19 pandemic.

Indian markets have matured over the years. Despite various restrictions and warnings by the market regulator, the derivative segment continues to grow. Derivative volume as a percent of cash volume at 422 times is the highest globally by a huge margin. The second highest ratio is that of Germany at 36 times, the US stands at 9, while Hong Kong is at 5.

On the flip side, since most of the trading is intra-day, the market carries little risk from overnight developments in the global markets.

The test of the market strength and the current Indian market structure will be seen in a market crash. Till such time, brokers and exchanges are not complaining.

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Shishir Asthana
Moneycontrol Pro 

Shishir Asthana
Shishir Asthana
first published: Oct 18, 2023 04:36 pm

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