Options, Not Cash Is King On D-Street

Options trading, a form of derivatives trading has become the game changer for the Indian capital market, forcing broking houses, which have built huge capacities to deal in the cash market, to rework strategies. Options trading constitute about 64 per cent of the total trading volume in the market in 2010-11, while the cash segment has turned minuscule, with just under four per cent. An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset (share or bond) at a specific price on or before a certain date. All this happened in the last 10 years, since 2000-01, when the cash segment commanded 99.9 per cent share of total volumes. The remaining was accounted for by the futures market. Last fiscal saw futures and options (F&O) together clocking a market share of 96.4 per cent, bringing down the share of cash market to just 3.6 per cent. Futures trading alone commands a share of 32.5 per cent. "The key driver for such phenomenal growth of the options market may be attributable to the fact that starting 2008-09, the brokerage and STT (Securities Transaction Tax) in the options market is being charged on the 'Premium' portion, than on the 'Entire Open Interest'( deal size)," said Jagannadham Thunuguntla, strategist and head of research of SMC Global Securities. The volumes of the cash segment fell from Rs 28.8 lakh crore in 2000-01, to Rs 11.08 lakh crore. On the other hand, the options market has grown Rs 193.96 lakh crore last fiscal, from almost nil in 2000-01. Futures market rose from Rs 4,041 crore to Rs 98.53 lakh crore during this period. "Though overall volumes have gone up in the market, the incomes of brokerages have not seen a commensurate growth, mainly due to shift in trading to derivatives," Thunuguntla added. Commissions on derivatives trading are lower than that in the traditional cash segment. The period 2001-02 to 2007-08 is considered the 'Era of Futures' (A financial contract obligating the buyer to purchase an asset or the seller to sell an asset, at a predetermined future date and price), when the futures trading grew from 7.4 per cent share of total trading volumes to 62.9 per cent. This was followed by the 'Era of Options', when its turnover shot up from 9.3 per cent in 2008 to 63.9 per cent last fiscal. Clearly, the cash market, where real shares are traded, has lost out in the race. Alex Mathews, research head of Geojit BNP Paribas Securities highlights the leverage that options give over the cash market as the main advantage of the former. "In the cash market, one has to pay the deal price, while an options buyer has to pay only the premium, which is around seven to eight per cent of the deal size," Mathews explained. For example, for a deal size of about Rs 2 lakh, an options buyer pays only about Rs 7,500. Thus, through options, one can take exposure to shares worth six to seven times the amount in the cash market. While trading and speculation strategies are possible in the cash market, options market provides opportunities in the volatile market and enables skimming arbitrage opportunities, too. "Options also enable trading with lower risk compared to that of futures," Mathews added.