We Don't Want More F&O Stocks... We Need Smaller Lot Sizes

Apurva Sheth

On 19 April 2017, the National Stock Exchange announced sixteen new stocks will trade on the futures and options (F&O) segment from 28 April 2017.

There are three main eligibility criteria to introduce a stock in the F&O segment:

  • It's a top-500 stock in terms of average daily market capitalisation and average daily traded value in the previous six months on a rolling basis.

  • The stock's median quarter sigma order size for the last six months is not less than 10 lakh.

  • The market-wide position limit in the stock shall not be less than 300 crore.

The exchange shortlists stocks that meet the these criteria and sends it to SEBI for approval. Once approved, the exchange introduces stocks to the F&O segment. (Read in detail here about the selection criteria.)

On 22 March 2017, the exchange announced the inclusion of fifteen stocks in the F&O segment in the April series. So over a period of two months, a total of 31 new stocks will be added in the F&O space.

Broke generally cheer new F&O stocks as more stocks mean more commissions. The exchange also benefits as more volumes mean more transaction charges. More volumes also help command better valuations.

But do new F&O stocks help the retail investor?

I don't think so.

Retail participation in the F&O space is very low due to the huge lot sizes. As per the SEBI rule, the minimum investment for equity derivative products in India should be Rs 5 lakh.

This was increased from two lakh in October 2015 to prevent small investors from entering high-risk products.

Most market participants did not welcome the decision. It was like banning driving because there are accidents. And now, introducing more stocks in the F&O segment is like building new highways no one can drive on.

From January 2015 to 22 April 2017, the exchange introduced sixty-seven stocks to the F&O segment and excluded only seven. For the May series, that gives us a total of 214 F&O stocks.

Now, that's a large number. But do so many stocks help retail participants?

Again, not really.

First, many retail investors can't afford to invest huge money as margin in the futures segment. This keeps them away from hedging their exposure in the cash market. Second, the bid-ask spread is generally very high for stocks not on the benchmark indices (e.g. Nifty or Sensex). And finally, the options market is practically dead in 80% of F&O stocks. Most F&O stocks do not have liquidity in options. Even at the money strike calls and puts of most stocks, do not have good volumes.

The last two problems existed even before lot sizes were increased in October 2015. The increase in lot sizes has certainly not helped the cause of retail investors. It has only hurt.

We believe, instead of blocking them, regulators should make it easier for retail investors to participate in the derivatives market.

To prevent road accidents, rather than ban people from driving ca, you'd probably build better infrastructure and support driver safety awareness programs.

We should likewise educate retail investors about the pros and cons of the derivatives market. And then allow them to test the waters with small lot sizes or mini contracts like they allow in the commodities market. We could even take a leaf from the US exchanges, where trading in F&O stocks is fixed at 100 shares.

However, they do have stricter guidelines for trading in the F&O segment. A US citizen needs to fulfill criteria like minimum networth, age and prior trading experience before he can trade in the F&O segment. These measures ensure that people who trade in the high-risk F&O segment are trained and know what they are doing.

At Profit Hunter, we believe we play an important role in the stock market ecosystem and it's our duty to educate the retail investor. That's why we plan to launch a free guide on derivatives soon. Watch this space for more details.


Market Notes

New Entrants a Threat to FMCG Incumbents?

The stock market is a strange place. On one side, the Indian telecom sector is consolidating, and on the other, new entrants are expanding the FMCG sector.

First, Patanjali Ayurveda took the FMCG sector by storm. Backed by 20 billion, the company repopularised ayurvedic products. Their unique products and rigorous marketing gave HUL, Colgate, and, Dabur something to think about.

And now the sector welcomes RP-Sanjiv Goenkars Group's brand, Too Yumm. The company entered the packaged food business under a new entity, Guiltfree Industries Ltd. It plans to invest more than 100 billion over the next five years in the FMCG space.

With these new entrants, the existing players have lost a bit of their market share. The competition in the sector has intensified.

But are the new entrants really a concern for the incumbents? Will they bring a serious setback in the S&P BSE FMCG Index?

Let's see what the FMCG index weekly chart has to say.

S&P BSE FMCG Index Uptrend Intact

S&P BSE FMCG Index Uptrend Intact

The index started its uptrend in June 2004 at 802. It hit a high of 2,383 in May 2006 and consolidated for three years before it resumed its up move. This up move was the strongest for the index. After the index hit a high of 7,600 in July 2013, the uptrend momentum slowed a bit. This can be seen clearly from the momentum indicator in the bottom panel of the chart.

The indicator remained above 200 when the index was in its strongest up leg (marked by green line), indicating strong momentum in the index. But after July 2013, the indicator traded in a downtrend and broke the 200 level in April 2014 (see blue dot in the chart).

Nevertheless, the index uptrend continued for a while as it hit a high of 8,812 in February 2015. But the momentum lagged. The momentum indicator hit a lifetime low in January 2016 (see red dot in the chart).

But today, the index is trading at its life high of 9,555 and the momentum indicator is trending up.

As we can see, the new entrants never created a drastic impact on the FMCG incumbents. Although the index lost some momentum, the uptrend is still intact.

From The Market Wizards...

"Risk control is the most important thing in trading." - Paul Tudor Jones

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