When futures and options were introduced in India, they were sold to investors as a way of protecting their portfolio from any sharp fall in the value of the underlying asset. Conceptually, that is how derivative instruments are designed and they have delivered repeatedly.
Yet, whenever there is a crisis in any single stock or the overall market, stock exchanges develop cold feet.
This time too, the National Stock Exchange (NSE) has decided to exclude DHFL from the equity derivatives segment from September 27, 2019. The company has repeatedly been downgraded by rating agencies after a series of defaults.
Banning derivatives when a stock is under pressure is not the right solution. The investor of the stock would be fully exposed to risk. When exchanges withdraw the derivatives option precisely at the time when investors need to hedge their positions will hurt the latter.
DHFL is not the first case where derivatives have been withdrawn when the stock is falling. Recently, Jet Airways faced similar treatment.
One way of looking at it is, why should derivatives be allowed in companies that do not have any business? In its circular on DHFL, the NSE said the decision to not allow derivatives in the company is based on the outcome of the recent board meeting where ‘significant doubt’ has been raised on the ability of the company to continue as a going concern.
The same logic should then also apply to the stock trading in the cash market. The stock should in such cases be delisted. If the exchange feels that DHFL can go bust, then it should also protect the shareholders of the company, and why only those traders in the derivative segment?
In any case, there is no need to ban a stock from the derivative segment when the exchanges have their favourite tool – margins –to monitor trading interest in the stock. At the drop of a hat, exchanges increase margins, be it before elections or budgets, and then simply forget to lift them.
A recent report by a committee constituted by the Securities and Exchange Board of India (SEBI) pointed out that Indian traders pay up to 500 times more margin than those in top global exchanges.
By increasing margins, exchanges can reduce interest in stocks where it feels would be risky for small traders. But investors who would like to hedge their position would at least have a way of doing it albeit at a higher cost. This way, investors can at least lock in their losses. By banning derivatives, the exchange is compelling the shareholders to take the entire loss.