chapter-4 nse (national stock exchange of india) cash and...
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Chapter-4
NSE (National Stock Exchange of India)
Cash and F&O Markets
Chapter- 4 NSE (National Stock Exchange of India) Cash and F&O Markets
4.1 Background of NSE
Capital market reforms in India have outstlipped the process of liberalization in
most other sectors of the economy. However, the creation of an independent capital
market regulator was the initiation of this reform process. After the formation of the
Securities Market regulator, the Securities and Exchange Board of India (SEBI), attention
were drawn towards the ineiTiciencies of the bourses and the need was felt for better
regulation, discipline and accountability. A Committee recommended the creation of a
2nd stock exchange in Mumbai called the "NariOlw/ Srock Exchange". The Committee
suggested the fonnation of an exchange, which would provide investors across the
country a single, screen based trading platform. operated through a VSAT network.
It was on this recommendation that setting up of NSE as a technology driven
exchange was conceptualized. NSE has set up its trading system as a nation-wide, fully
automated screen based trading system. It has written for itself the mandate to create a
world-class exchange and use it as an instrument of change for the industry as a whole
through competitive pressure. NSE was incorporated in 1992 and was given recognition
as a stock exchange in April 1993. It started operations in June 1994. with trading on the
Wholesale Debt Market Segment. Subsequently it launched the Capital Market Segment
in November 1994 as a trading platform for equities and the Futures and Options
Segment in June 2000 for various derivative instruments.
NSE was set up with the objectives of:
• Establishing a nationwide trading facility for all types of securities;
• Ensuring equal access to investors all over the country through an appropriate
communication network;
• Providing a fair, efficient and transparent securities market USlllg electronic
trading system;
• Enabling shorter settlement cycles and book entry settlements; and
• Meeting international benchmarks and standards.
106
NSE has been able to take the stock market to the doorsteps of the investors. The
technology has been harnessed to deliver the services to the investors across the country
at the cheapest possiblc cost. It provides a nation-wide. screen-based, automated trading
system, with a high degree of transparency and equal access to investors irrespective of
geographical location. The high level of information dissemination through on-line
system has helped in integrating retail investors on a nation-wide basis. The standards set
by the exchange in terms of market practices, products, technology and service standards
have become industry benchmarks and are being replicated by other market participants.
Within a very shol1 span of timc. NSE has been able to achieve all the objectives
for which it was set up. It has been playing a leading role as a change agent in
transforming the Indian Capital Markets to its present form. The Indian Capital Markets
are a far cry from what they used to be a decade ago in terms of market practices.
infrastructure, technology, risk management, clearing and scttlement and investor service.
Table-4.1 Chronological Establishmcnt of the NSE
Event Dale Elapsed timc (lears)
Idea. first proposed June 1991 0
Decision to build market NovcllliJf'r 1992 1.4
M,mageria Iteam in pbct, J.ll1llalY 1993 1.6
Market design re.Jllicd May 1993 1.9
Regulatory clearances ubtaincd DCCl'llliJer 19'13 2 -.:>
Firstintcnnediaryenrolled l,lIludry 1 f)9-l 2.6
Stdrt of trading November 1994 3,4
Takeoff NovemlX'r 199.5 -1.-1
4.2 Market Segments of NSE
NSE provides an electronic trading platform for of all types of securities for
investors under one roof - Equity. Corporate Debt. Central and State Government
Securities. T-Bills, Commercial Papers (CPs), Certificate of Deposits (CDs). Warrants,
Mutual Funds (MFs) units, Exchange Traded Funds (ETFs). Derivatives like Index
Futures, Index Options, Stock Futures. Stock Options, Futures on Interest Rates etc.,
107
which makes it one of the few exchanges in the world providing trading facility for all
types of securities on a single exchange. The Exchange provides trading in 3 different
segments viz., Wholesale Debt Market (WDM) segment. Capital Market (CM) segment
and the Futures & Options (F&O) segment. Details of all three segments are as below.
Market Segments
I. Wholesale Debt Market segment:
The Wholesale Debt Market segment provides the trading platform for
trading of a wide range of debt securities, which includes State and Central
Government securities, T-Bills, PSU Bonds, Corporate Debentures, CPs, CDs etc.
However, along with these financial instruments, NSE has also launched various
products e.g. FIMMDA-NSE MIBIDfMIBOR owing to the market need. A
reference rate is said to be an accurate measure of the market price. In the fixed
income market. it is the interest rate that the market respects and closely matches.
In response to this, NSE started computing and disseminating the NSE Mumbai
Inter-bank Bid Rate (MIBID) and NSE Mumbai Inter-Bank Offer Rate (MIBOR).
Owing to the robust methodology of computation of these rates and its extensive
use, this product has become very popular among the market pal1icipants.
Keeping in mind the requirements of the banking industry, Fls, MFs, insurance
companies, who have substantial investments in sovereign papers, NSE also
started the dissemination of its yet another product. the 'Zero COUpOIl Yield
Curve'. This helps in valuation of sovereign securities across all maturities
irrespective of its liquidity in the market. The increased activity in the government
securities market in India and simultaneous emergence of MFs (Gilt MFs) had
given rise to the need for a well-defined bond index to measure the returns in the
bond market. NSE constructed such an index the, 'NSE Government Securities
Index'. This index provides a benchmark for portfolio management by various
investment managers and gilt funds.
II. Tbe Capital Market segment
The Capital Market segment offers a fully automated screen based trading
system. known as the National Exchange for Automated Trading (NEAT) system.
108
l
d
This operates on a price/time priolity basis and enables members from aeross the
country to trade with enom10US ease and efficiency. Various types of securities
e.g. equity shares, warrants, debentures etc. are traded on this system. The average
daily turnover in the CM Segment of the Exchange during 2006-07 was nearly Rs.
15.036 crores.
III. Futures & Options segment
Futures & Options segment of NSE provides trading in derivatives
instruments like Index Futures. Index Options, Stock Options, Stock Futures and
Futures on interest rates. Though only four years into its' operations. the futures
and options segment of NSE has made a mark for itself globally. In the Futures
and Options segment, trading in Nifty and CNX IT index and 203 single stocks
are availablc. W.c.f. June 1 2007, futures and options would be available on 213
single stocks. The average daily turnover in the F&O Segment of the Exchange
during 2006-07 was nearly Rs. 45.000 crores.
£:\1
\\1 )\1
l·&()
TOlal
Table- 4.2 NSE Market segments details
No. of "~::>11~~~n'~,.Market ~Icmbcrs <:.:::~~;:' Securities/ , ,: ~~'~lia,lisation
~.-;:~~t.:.:;.;:.!.-: .•. :.'.-IT~.·.;-: Contracts :~il'jl~J{Jl~- crorc) ~ ;;;;~:<k. - Available qrljil~~J~f;:.'
1,01.12
(1.1
X~S
t,OOI)<.I
3252
U,U41 h
3,.1(7):'()
1,7~.\.R')1
-l'ratling Volume
(Rs.'ttQrc) nn:
1.()4:\2K~
219,10()
9,52U,r'(I-l
+l(),2h'J
~O,2('.;;
IJ)~"7,6U:1
2,18.\,1,\1) --~---------
(:_xclullc;, :".u;'l)Clllkd ~Turitie~.
Inclll~k~ .) ~ifty !ufun:.., .. l (::":X IT FUlurt.'~ •. ) bank nifty, 334 nifty inde" opli(lIl~,4()2 ~I()ck tUlUrt._~, .;(10 (:~X IT "Plj\fll~ ,4:")B bank indl:'i. !'\lIions, 11,-1.1.11.-' "r()(k upli()f) and t8- illtnc;-.{ r.I!C r\lrllrC~ (ontf,lCl:-.
lndudc:, nlJ(iUll.l1 IUfI1U\C! [(SlriJ..<.' Price + Pn:millm) X (2lunlily1 in C.1~1.' of ind\.'x oplillll:' :\nd :.tDck "I)\i,m~.
DC) n,)\ .\d~1 up III lulal bec.w:.c of multip!.: Il1l'mhlTShip,
The year 2006-07 witnessed a total trading volume of Rs. 9,520,664 crore (US $
2.184,140 million) as against Rs. 6.869,332 crore (US $ 1,575,896 million) in the
preceding year.
109
4.3 NSE Cash Market
The National Stock Exchange commenced its operations in 1994 as a first step in
reforming the securitics market through improved technology and introduction of best
practices in management. It started with the concept of an independent governing body
without any broker representation thus ensuring that the operators' interests were not
allowed to dominate the governance of the exchange. Before the NSE was set up. trading
on the stock exchanges in India used to take place through open outcry without use of
information technology for immediate matching or recording of tradcs.
This was time consuming and inefficient. The practice of physical trading
imposed limits on trading volumes as well as, the speed with which new information was
incorporated into prices. To obviate this, the NSE introduced Screen Based Trading
System (SBTS) where a member can punch into the computer the quantities of shares and
the prices at which he wants to transact. The transaction is executed as soon as the quote
punched by a trading member finds a matching sale or buys quote from counter-party.
SBTS electronically matches the buyer and seller in an order-driven system or finds the
customer the best price available in a quote-driven system, and hence cuts down on time,
cost and risk of error as well as on the chances of fraud. SBTS enables distant
participants to trade with each other, improving the liquidity of the markets. The high
speed with which trades are executed and the large number of participants who can trade
simultaneously allows faster incorporation of price-sensitive information into prevailing
prices. This increases the informational efficiency of markets. With SBTS, it becomes
possible for market participants to see the full market, which helps to make the market
more transparent, leading to increased investor confidence. The NSE started nation-wide
SBTS, which have provided a completely transparent trading mechanism. Regional
exchanges lost a lot of business to NSE, forcing them to introduce SBTS. Today, India
can boast that almost 100% trading takes place through electronic order matching.
Prior to the setting up of NSE. trading on stock exchanges in India took place
without the usc of information technology for immediate matching or recording of trades.
The practice of physical trading imposed limits on trading volumes as well as the speed
with which the new information was incorporated into prices. The unscrupulous operators
used this information asymmetry to manipulate the market. The information asymmetry
110
f- helped brokers to perpetrate a manipulative practice known as "gala". Gala is a practice
of cxtracting highest price of the day for "buy" transaction irrespective of the actual price
at which the purchase was actually done and give lowest price of the day for "sell"
transactions irrespective of the price at which sale was made. The clients did not have any
method of verifying the actual price. The electronic and now fully online trading
introduced by the NSE has made such manipulation difficult. It has also improved
liquidity and made the entire operation more transparent and efficient.
The NSE has set up a clearing corporation to provide legal counterparty guarantee
to each trade thereby eliminating counterparty risk. The National Securities Clearing
Corporation Ltd. (NSCCL) commenced operations in April 1996. Counterparty risk is
guaranteed through fine-tuned risk management systems and an innovative method of on
line position monitoring and automatic disablement. Principle of "innovation" is
implemented by NSE capital market segment. Under this principle, NSCCL is the
counterparty for every transaction and, therefore, default risk is minimized. To support
the assured settlement, a "settlement guarantee fund" has been created. A large settlement
guarantee fund provides a cushion for any residual risk. As a consequence, despite the
fact that the daily traded volumes on the NSE run into thousands of crores of rupees,
credit risk no longer poses any problem in the marketplace.
4.3.1 Clearing & Settlement
While NSE provides a platform for trading to its trading members, the National Securities
Clearing Corporation Ltd. (NSCCL) determines the funds/securities obligations of the
trading members and ensures that trading members meet their obligations. Thc core
processes involved in clearing and settlemcnt are:
• Trade Recording: The key details about the trades are recorded to provide basis
for settlement. These details are automatically recorded in the electronic trading
system of the exchanges.
• Trade Confirmation: The parties to a trade agree upon the terms of trade like
security, quantity, price, and settlement date, but not the coullterparty, which is
the NSCCL. The electronic system automatically generates confirmation by direct
participants.
I II
• Determination of Obligation: The next step is determination of what counter
parties owe. and what counter-parties are due to receive on the settlement date.
The NSCCL interposes itself as a central counterparty between the counterparties
to trades and nets the positions so that a member has security wise net obligation
to receive or deliver a security and has to either payor receive funds.
• Pay-in of Funds and Securities: The members bring in their funds/securities to
the NSCCL. They make available required seclllities in designated accounts with
the depositories by the prescribed pay-in time. The depositories move the
securities available in the accounts of members to the account of the NSCCL.
Likewise members with funds obligations make available required funds in the
designated accounts with clearing banks by the prescribed pay-in time. The
NSCCL sends electronic instructions to the clearing banks to debit member's
accounts to the extent of payment obligations. The banks process these
instructions. debit accounts of members and credit accounts of the NSCCL.
• Pay-out of Funds and Securities: After processing for shortages of
funds/securities and arranging for movement of funds from surplus banks to
deficit banks through RBI clearing, the NSCCL sends electronic instructions to
the depositories/clearing banks to release pay-out of secUlities/funds. The
depositOlics and clearing banks debit accounts of the NSCCL and credit accounts
of members. Settlement is complete upon release of payout of funds and securities
to custodians/members.
• Risk Managcmcnt: A sound risk management system is integral to an efficient
settlement system. The NSCCL ensures that trading members' obligations are
commensurate with their net worth. It has put in place a comprehensive risk
management system, which is constantly monitored and upgraded to pre-empt
market failures. It monitors the track record and performance of members and
their net worth; undertakes on-line monitoring of members' positions and
exposure in the market collects margins from members and automatically disables
members if the limits are breached. The risk management methods adopted by
NSE have brought the Indian financial market in line with the international
markets. The robustness of the risk management system of NSE was amply
112
proved by the timely and default free settlement on highly volatile days like May
14 & ]7, 2004, the two days when the market witnessed a fall of nearly 7.87% &
12.24% respectively. However, due to the robustness of the NSE's risk
management system, tight controls of member positions. stlingent margining etc.
the settlements went through smoothly without any disruptions or disorder in the
markets.
4.3.2 Settlement Agencies
The NSCCL, with the help of clearing members, custodians, clearing banks and
depositories settles the trades executed on exchanges. Tbe roles of each of these entities
are explained below:
• NSCCL: The NSCCL is responsible for post-trade activities of a stock exchange.
Clearing and settlement of trades and risk management are its central functions. It
clears all trades, determines obligations of members, arranges for pay-in of
funds/securities, receIves funds/ securities, processes for shortages In
funds/securities, arranges for pay-out of funds/ securities to members, guarantees
settlement, and collects and maintains margins/collateral! base capital!other funds.
It is the countcrparty to all settlement obligations of the members.
• Clearing Members: They are responsible for settling their obligations as
deterrnined by the NSCCL. They have to make available funds and/or securities
in the designated accounts with clearing bank/depositories, as the case may be, to
meet their obligations on the settlement day.
• Custodians: Custodian is a clealing member but not a trading member. He settles
trades assigned to him by trading members. He is required to confirm whether he
is going to settle a particular trade or not. If it is confirmed, the NSCCL assigns
that obligation to that custodian and the custodian is required to settle it on the
settlement day.
113
• Clearing Banks: Every clearing memher is required to open a dedicated clearing
account with one of the clearing hanks. Based on his ohligation as determined
through clearing. the clearing member makes funds available in the clearing
account for the pay-in and receives funds in case of a payout.
• Depositories: Depositories help in the settlement of the dcmaterialized securities.
Each custodianJclearing member is required to maintain a clearing pool account
with the depositories. He is required to make available the required securities in
the dcsignated account on settlement day. The depository runs an electronic file to
transfer the securities from accounts of the custodians/clearing member to that of
NSCCL. As per the schedule of allocation of securities detem1ined by the
NSCCL, the depositories transfer the securities on the pay-out day from the
account of the NSCCL to those of members/custodians.
• Professional Clearing lVlember: NSCCL admits special category of members
namely, professional clearing members. Professional Clearing Member (PCM)
may clear and settle trades executed for their clients (individuals. institutions etc.).
In such an event, the functions and responsibilities of the PCM would be similar
to Custodians. PCMs may also undertake clearing and settlement responsibility
for trading members. In such a case, the PCM would settle the trades carried out
by the trading members connected to them. A PCM has no trading rights but has
only clearing rights, i.e. he clears the trades of his associate trading members and
institutional clients.
114
4.3.3 Settlement Cycles
NSCCL clears and settles trades as per well-defined settlement cycles, as
presented in Table-4.3. Since the beginning of the financial year 2003, all securities are
being traded and settled under T +2 rolling settlement. The NSCCL notifies the
consummated trade details to clearing mcmbers/ custodians on the trade day. The
custodians aftinn back the tradcs to NSCCL by T + I day. Based on the affirmation,
NSCCL nets the positions of counterparties to determine their obligations. A clearing
member has to pay-in/pay-out funds and/or securities. A member has a security-wise net
obligation to receive/deliver a security. The obligations arc netted for a member across all
securities to determine his fund obligations and he has to either payor receive funds.
Members' pay-inJpay-out obligations are determined latest by T + 1 day and are forwarded
to them on the same day so that they can settle their obligations on T +2 day. The
securities/funds arc paid-in/ paid-out on T +2 day and the settlement is complete in 3 days
from the end of the trading day.
liS
Table- 4.3 Settlement Cycle in Capital Market Segment
Activity T +2 Rolling Settlement
Trading T
Custodial Confirmation T+l
Determination of Obligation T+I
Securities/Funds Pay-in T+2
Securities/Funds Pay-out T+2
Valuation Debit T+2
Auction T+3
Bad Delivery Reporting T+4
Auction Pay-iniPay-out T+5
• Close Out T+5 • R~\tificd Bad Delivery Pay-in/Pay-out T+6
Re-bad Delivery Reporting T+8
Close Out of Re-bad Delivery T+9
Fig-4.1 Business Growth of NSE Capital Market Segment
2SI I,llilll ,------------------------------T I II,! ~ iii
" ~) ,l,Il ~ I , ~
?(III,'11111 h,lll )41 ;,;; ~
-:,11011
~ (,.1111()
\(11)(1 ';j
1011,1 11 111 -I)IIMI 0 , ,.(11 M I ~J)
" 2,1 II ~ I " .< ;'11,1 H II I
1,(1(111
, I " - LL: ~
r, r; ~, r, r,
" c ,
2 " ~ ; ;;:
:r " ~ ::::i 0- ~ 0- ,
~ ~ c ,
i. ;;: 1
'" L L "L t-=-I '.:1 g , 0- - F, ~i C. C, " "3 ~ , ~ " , -- .0 , " ;;: ; ;;: 1 ~" ;
Month & YC;lr
116
4.4 NSE Futures & Options Market
The derivatives trading on NSE commenced on June 12111 2000 with futures
trading on S&P CNX Nifty Index. Subsequently the product base has been increased to
include trading in options on S&P CNX Niliy Index, futures and option on CNX IT
Index, futures and options on single stocks (213 stock as at end June 20(7) and futures on
interest rate. The turnover in the derivatives segment has witnessed considerable growth
since inception. In the global market NSE ranks first (1'1) in terms of number of contracts
traded in the Single Stock Futures, second (2"'1) in Asia in terms of number of contracts
traded in equity derivatives instrument. Since inception, NSE established itself as the sole
market leader in this segment in the country with more than 99% market share.
Fig-4.2 NSE F&O Business Growth
HIIII,U()O .,---------------------------, -l5,OOO
7(1IJ,OO{l 411,01111
(l! \()Jll'll)
~ .itlll,OO(1
35,otlO E
~ ell ·lIIO,OOII
~ ~ J.IIJ,OI){1
, 3D,OOIl ~
'" 25,U()(J ~
" '"10110(1 r!:: - ,- - - :>.
';i 15,000 Q
10.(1)0 ~ ~
5,tlO()
(j
Following Fig-4.3 will givc comparison betwecn NSE Cash and F&O Market growth and
clearly retlected that F&O Market has out stripped Cash market by miles.
117
Fig-4.3 Monthly Turnover at Cash and Derivatives Segments of NSE (Rs. in Crore)
8()(X)00
70WOO 60(x)OI.)
50WOO 40C()OO
30WOO 2()WO()
-a- Equllres
10lXlOO o ..Jt+H#tt-t-t=I ~iIi!iIi ~i!i.!Ei!i!~~~=-=----==~~ __ _
::: -,
o "I
-x N ;:: ::: --,
-0 ~ "! "·1 t: ~
;., ~ -
"I ~ ,..., -- 25 -~ "! "I
~
.:--::: '"' ,..., '-'
~ ~
~ :t .". Or - 0 ~ 0 25 -. 25 - -'";1 ~ N '";1 N ~ 0
c ..!. ::: .... :,.; ::: '"' ~ ,...,
"" -, ,..., ~ ~
Fig-4.4 Progress of Futures & Options Markets on NSE
-Launch on June 13 2005 of BANK Nifty
O/', -0 N C -,
Steps to new heights ............ . ·lntroduCE;d 65 new securities ·Enhancement of number of strikes for
--'NlJmb>?r 1 i~--I NIFTY Options SIry:k Futures \--._...... • - . .1
. jll tb,::. ·.A,ne!."! I 'Instltutional
,.--~-----; participation 'Introduced at Its highest CNX IT & additional r---.---..-..i securities , ·Launch of Interest Rate,
-12 new FutUres I -- - securities __
"I ;!'!.!LOO",cILLJ _--,QCilf were added . .,.--- .----
Products ·Achieved I 'Index Options new heights ~NIFTY) in all our
'Stock Options ----.-------~ 'Stock Futures projucts
On JlIn~ 12. L.:lrgest '-c- -- -'
zr{ln Q,:;:rjvatlYes ·Launch of the ExcharKJe in Futures &. India optic,ns r- .. --.--Segment , ·Product Index. Futures - S&P I CNX NIFTY •
2000-01 2001-02 2002-03 2003-04 2004-05 2005 onwards
6 '-C ::Q 0 - - 25 N ~·t ";l ..!. ~ c y -;:; ::: ~ ;.,... ....,
118
4.4.1 Futures and options market instruments
The National Stock Exchange of India Limited has launched different products as
an instrument for trading over the period of years. The instruments are:
I. S&P CNX Nifty Futures
2. S&P CNX Nifty Options
3. CNXIT Futures
4. CNXIT Options
5. Bank Nifty Futures
6. Bank Nifty Options
7. Futures on Individual Securities
8. Options on Individual Securities
Growth of various F&O Market instrument from the beginning of the trade can be seen
from following graph.
Fig-4.5 Share of Various Derivative Instruments in Turnover in Derivatives
Segment of NSE
40 "Yo
20%
or. =0
~ ~ -=> ~.' ":'
"-""
" :::E
0
"" '" "-J>:
~.
=0
;:;; ~
~
o lnd:-x O;~inn~ ,Call'
a Stn.:k () p[iol1~ ! 1\,,}
119
;? :5 ~ ":' " ~
;!
The advantages of trading in [ndex Futures are:
• The contracts are highly liquid
• Index Futures provide higher leverage than any other stocks
• [t requires low initial capital requirement
• It has lower risk than buying and holding stocks
• It is just as easy to trade the short side as the long side
• Only have to study one index instead of [OO's of stocks
• Settled in cash and therefore all problems related to bad delivery, forged, fake
certificates, etc can be avoided.
The reasons for stock index futures emerglllg as the most popular Derivative
Instrument are as follows
• Institutiona[ and other large equity holders tend to concentrate their attention
on p0l1folio hedging.
• Index futures are the Illost cost-efficient hedging devices.
• A stock index unlike individual stock prices cannot be easily manipulated.
• Stock index futures are Illore liquid and more popular than individual stock
futures.
Tab[e-4.4 Market Share for the different products in the NSE Derivative Scgmcnt
Year Index Stock Index Stock
Futures Futures Options Options
2006-2007 30.50'70 58.20% 8.30% 3.00%
200S-2006 31.38'70 57.87% 7.02% 3.74%
2004-200S 30.32'70 58.27% 4.79% 6.63%
2003-2004 26.03% 61.30% 2.48% 10.20%
2002-2003 9.99% 65.14% 2.10% 22.76%
2001-2002 21.08'70 50.54% 3.69% 24.69%
2000-2001 100.00% - - -
Tab[c-4.S National stock Exchange (NSE) has the following derivative products
120
Products Index Futures Index Options Futures on Options On Individual Individual Securities Securities
Underlying S&P CNX Nifty S&P CNX Nifty 213 securities 213 securities Instrument stipulated by stipulated by
SEB! SEBI Type European American Trading Cycle Maximum of 3- Same as Index Same as index Same as index
Month trading futures futures futures cycle. At any point in time, There will be 3 Contracts available
I) near month. 2) mid month & 3) far month duration
Expiry Day Last Thursday of Same index Same as index Same as index the
as
expiry month futures futures futures Contract Size Pem1itted lot size Same index As stipulated As stipulated by
as IS by 200 & multiples futures NSE (not less NSE (not less thereof than Rs.2 lacs) than Rs.2 lacs)
Price Steps Re.0.05 Re.0.05 Base Price- Previous day Theoretical value previous day Same as Index
closing First day Nifty value of the options closing value of options of trading contract anived at underlying
based on Black- security Scholes model
Base Price- Daily settlement daily close price Daily Same as Index settlement
Subsequent price price options Price Bands Operating ranges Operating ranges Operating Operating
are kept at + 10 % for are kept at ranges are kept ranges for are
99% of the base at+ 20 % kept at 99% of pnce the base price
Quantity Freeze 20,000 units or 20,000 units or Lower of I % of Same as
greater greater Market wide individual
position limit futures
121
• The stock index being an average is less volatile than individual stock prices.
In a futures market. the clearing house stands as the guarantor, and its risk is
minimized if the stock index is used.
• Futures on individual stocks can be used as a vehicle for manipulating their
prices in the cash market.
• Regulatory complexity is less in the case of stock index futures than in other
kinds of equity derivatives.
4.4.2 Futures and options market Contract cycle
The figure shows the contract cycle for futures contracts on NSE's derivatives
market. As can be seen, at any given point of time, three contracts are available for
trading a near-month, a middle-month and a far-month. For example as the January
contract expires on the last Thursday of the month, a new three-month contract starts
trading from the following clay, once more making available three index futures contracts
for tracling.
Fig 4.6 NSE Futures and options market Cycle
Jan
Jan 30 .:ontr,,,t ~
Feb 27 .:ontract ..
\hr
\!ar 27 contract 4 ~
Apr 2~ contract •
\!ay 29 contract
Apr .. Tim~
Jun 26 contract
4.4.3 Futures and options market Contract Specification
The contract specification for derivatives tracled on NSE is summarized as below.
The index futures and index options contracts traded on NSE arc based on S&P CNX
Nifty Index and CNX IT Index, while stock futures and options are based on individual
securities traded in the Capital market segment of NSE. Interest rate future contracts are
122
available on Notional 91 day t-bill and Notional 10 year bonds (6% coupon bearing and
zero coupon bond). While the index options are European stylc. stock options are
Amcrican style. At any point of time there arc three contract months available for trading.
with I month, 2 months and 3 months to expiry. These contracts expire on last Thursday
of the expiry month and have a maximum of 3-month expiration cycle. A new contract is
introduced on the next trading day following the expiry of the near month contract. All
the derivatives contracts are presently cash settled.
Contract Specifications of Equity based derivatives traded in NSE
Ulltier/rill" _ b
I. Indc" Futures anu Options
2. Futures/Options on Inuividual Indiviuual Sccurities
Exchallge of Trade
: S&P CNX Nifty and CNX IT
: IlllliYidual Securities. At present 53 stocks
National Stock Exchange of India Limited
SeclIrity descriptor
I. S&P CNX Nifty Futures N FUTlDX NIFTY i\IATURITY DATE 2. S&P CNX Nifty Options N OPTIDX NIFTY i\IATURITY DATE
STRIKE PRICE OPTYP 3. Futures on individual securities N FUTSTK ABC MATURITY DATE ~. Options on individual sccuritiesN OPTSTK ABC \lATURITY DATE
STRIKE PRICE OP TYP
Contract Size
I.
2.
S&P CNX Nilly Futures / S&P CNX Nifty Options
Futures / Options on individual securities
Strike price illtenal
Permitted lot size 200 and multiples then: of (minillluill value Rs.2 Iakh)
Minimulll value of Rs 2 Lakh for each Individual Security
1. sSeP CNX Nifty Options Rs. 10/-
Options un individual securities:
PricL' Steps
Price Banus
Between Rs.2.50 and Rs. 100.00
dcpellllin~ on the price or underlvin~ c ~ U
Rs.0.05
i\ut Applicahk
123
Trading Cycle
Expiry dat.:
Settlement basis
I.
2.
3.
Indn Futures / Futures
on individual securities
Index Options
Options on individual
securities
Settlement price
I. S&P CNX Nifty Futures / Futures
Illdex Options /options
on individual security
i\laximuIll Df three montil trading cycle
- n.:ar Illontil( one). tile next month (twO)
and th.: far mllnth (three I. Nc\\ seriL~s
of contract \\-ill he introduCL'd on till' n.:xt
trading day follll\ving expiry of ncar
Illontil contract
Thc last TiltH-,day of the cxpiry nllJnth
or the Previous trading d~IY if th.: last
Thursdav of til.: Illontil is ;1 tradinl.! _ c
iloliday
Mark to Market and final scttlement
be settled in cash on T + I basis
Premium settleillent on T + I Basis and
Final Exercise settleillent on T + I basis
Preillium settlement on T + I basis ami
option Exercise settlement on T +2 basis.
Daily settlement price will be the closing price on individual sccurities of the
futures contracl', for the trading day and
the I1nal settlemcnt price shall be the c1osin~ value of the underhin,! index/
~- ~ ~
security on the last trading day ~ <,.. ~
The settlemcnt price shall be closing
I)ricc of underJviw' security _ c •
4.4.4 Introduction of strike prices for option contracts
NSE introduces option strikes on a daily basis based on the pnce of the
underlying. With regard to options on stocks and CNX IT index the Exchange provides a
minimum of seven strike prices for every option type (i.e. Call & Put) during the trading
month. At any time, there are at least three strikes in-the-money (ITM), three strikes out
of-thc-money (OTM) and one strike at-the-money (ATM). The number of strikes
provided in options on Nifty, Nifty Junior, CNX 100, CNX IT and Bank Nifty are related
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to the range in which prevIous day's closing value of Nifty index falls as per the
following table
Table-4.6 Strike Prices for Option Contracts
Nifty Index Level Strike Interval Scheme of strikes to be Introduced
(ITM-ATM-OTM)
Up to 2000 25 4-1-4
> 2001 up to 4000 50 4-1-4
>4001 up to 6000 50 5-1-5
> 6000 50 6-1-6
4.4.5 Eligibility Criteria for selection of Securities and Indices
SEBI vide its Circular NO.SEBIIDNPD/Cir-26/2004/07116 dated July 16, 2004
has revised the eligibility criteria for introducing Futures & Options contracts on Stocks
and Indices. Based on the above circular, the following criteria will be adopted by the
Exchange w.e.f September 1,2004, for selecting stocks and indices on which Futures &
Options contracts would be introduced.
1. Eligibility criteria of stocks
o The stock shall be chosen from amongst the top 500 stocks in terms of
average daily market capitalization and average daily traded value in the
previous six months on a rolling basis.
o The stock's median quarter-sigma order size over the last six months shall
be not less than Rs, 0.10 million (Rs. 1 lac). For this purpose, a stock's
quarter-sigma order size shall mean the order size (in value terms)
required to cause a change in the stock price equal to one-quarter of a
standard deviation.
o The market wide position limit in the stock shall not be less than Rs. 500
million (Rs. 50 crores). The market wide position limit (number of shares)
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shall be valued taking the closing prices of stocks in the underlying cash
market on the date of expiry of contract in the month. The market wide
position limit of open position (in terms of the number of underlying
stock) on futures and option contracts on a particular underlying stock
shall be lower of:
30 times the average number of shares traded daily, during the
previous calendar month, in the relevant underlying security in the
underlying segment,
or
• 20% of the number of shares held by non-promoters in the relevant
underlying security i.e. free-float holding.
o If an existing security fails to meet the eligibility criteria for three months
consecutively, then no fresh month contract shall be issued on that
security.
o Further, the members may also refer to circular no. NSCCIF&OIC&S/365
dated August 26, 2004, issued by NSCCL regarding Market Wide Position
Limit, wherein it is clarified that a stock which has remained subject to a
ban on new position for a significant part of the month consistently for
three months, shall be phased out from trading in the F&O segment.
However, the existing unexpired contracts may be permitted to trade till expiry
and new strikes may also be introduced in the existing contract months.
2. Eligibility criteria of'Indices
o Futures & Options contracts on an index can be introduced only if 80% of
the index constituents are individually eligible for derivatives trading.
However, no single ineligible stock in the index shall have a weightage of
more than 5% in the index. The index on which futures and options
126
contracts are permitted shall be required to comply with the eligibility
criteria on a continuous basis.
o SEEI has subsequently modified the above criteria; vide its clarification
issued to the Exchange "The Exchange may consider introducing
derivative contracts on an index if the stocks contributing to 80%
weightage of the index are individually eligible for derivative trading.
However, no single ineligible stocks in the index shall have a weightagc of
more than S% in the index."
o The above criteria is applied every month, if the index fails to meet the
eligibility criteria for three months consecutively, then no fresh month
contract shall be issued on that index, However, the existing unexpired
contacts shall be permitted to trade till expiry and new strikes may also be
introduced in the existing contracts.
3, Selection criteria for unlisted companies
For unlisted companies corning out with initial public offering, if the net
public offer is Rs. 500 crs. or more, then the Exchange may consider introducing
stock options and stock futures on such stocks at the time of its' listing in the cash
market. New securities being introduced in the F&O segment are based on the
eligibility criteria which take into consideration average daily market
capitalization, average daily traded value, the market wide position limit in the
security, the quarter sigma values and as approved by SEE!. The average daily
market capitalization and the average daily traded value would be computed on
the 15 th of each month, on a rolling basis, to arrive at the list of top 500 securities.
Similarly, the quarter sigma order size in a stock would also be calculated on the
I Sth of each month, on a rolling basis, considering the order book snapshots of
securities in the previous six months and the market wide position limit (number
of shares) shall be valued taking the closing prices of stocks in the underlying
cash market on the date of expiry of contract in the month.
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------------------------------------ -------- ----
4.4.6 Trading Mechanism
The derivatives trading system at NSE is called NEAT-F&O trading system. It
provides a fully automated, screen-based trading for all kind of derivative products
availahle on NSE. It supports an anonymous order driven market, which operates on a
strict price/time priority. It provides tremendous flexibility to users in terms of kinds of
orders that can be placed on the system. Various time and price related conditions like
Immediate or Cancel. LimitlMarket Price. Stop Loss. etc. can be built into an order.
The NEAT-F&O trading system distinctly identifies two groups of users. The
trading user more popularly known as trading member has access to functions such as,
order entry, order matching and order & trade management. The clearing user (clearing
member) uses the trader workstation for the purpose of monitoring the trading member(s)
for whom he clears the trades. Additionally, he can enter and set limits on positions,
which a trading member can take.
The Trading Members(TM) have access to functions such as order entry, order
matching, order and trade management. It provides tremendous flexibility to users in
terms of kinds of orders that can be placed on the system. Various conditions like Good
till-Day, Good-till-Cancelled, Good-till-Date, Immediate or Cancel, LimitlMarket price,
Stop loss, etc. can be built into an order. The trading terminals of F&O segment are
available in 500 cities at the end of March 2007. Besides the trading can also be carried
through the Internet by investors.
4.4.7 Membership criteria
NSE admits members on its derivatives segment in accordance with the rules and
regulations of the exchange and the norms specified by SEB!. NSE follows 2-tier
memhership structure stipulated by SEBI to enable wider participation. Those interested
in taking membership on F&O segment are required to take membership of CM and F&O
segment or CM, WDM and F&O segment. Trading and clearing mcmbers are admittcd
separately. Essentially, a Clearing Member (CM) docs clearing for all his Trading
Members (TMs), undertakes risk management and performs actual settlement. There are
three types of CMs:
128
• Self' Clearillg Member: A SCM clears and settles trades executed by him only
either on his own account or on account of his clients.
• Trolling Member Clearillg Member: TM-CM is a CM who is also aTM. TM-CM
may clear and settle his own proprietary trades and c1ient"s trades as well as clear
and settle for other TMs.
• Professiollal Clearillg Member rCM is a CM who is not a TM. Typically, banks
or custodians could become a PCM and clear and settle for TMs.
4.4.8 Clearing and settlement
NSCCL undertakes clearing and settlement of all deals executed on the NSEs
F&O segment. It acts as legal counterparty to all deals on the F&O segment and
guarantees settlement.
4.4.8.1 Clearing
The first step in clearing process is working out open positions or obligations of
members. A CM's open position is arrived at by aggregating the open position of all the
TMs and all custodial participants clearing through him, in the contracts in which they
have traded. A TM's open position is arrived at as the summation of his proprietary open
position and clients open positions. in the contracts in which they have traded. While
entering orders on the trading system, TMs are required to identify the orders, whether
proprietary (if they are their own trades) or client (if entered on behalf of clients).
Proprietary positions are calculated on net basis (buy-sell) for each contract. Clients'
positions are anived at by summing together net (buy-sell) positions of each individual
client for each contract. A TMs open position is the sum of propIietary open position,
client open long position and client open short position.
4.4.8.2 Settlement
All futures and options contracts are cash settled. i.e. through exchange of cash.
The underlying for index futures/options of the Nifty index cannot be delivered. These
contracts, therefore. have to be settled in cash. Futures and options on individual
securities can be delivered as in the spot market. However, it has been currently
129
mandated that stock options and futures would also be cash settled. The settlement
amount for a CM is netted across all their TMs/clients in respect of MTM. premium and
final exercise settlement. For the purpose of settlement, all CMs are required to open a
separate bank account with NSCCL designated clearing banks for F&O segment.
4.4.8.2.1 Settlement of Futures Contracts on Index or Individual Securities
Futures contracts have two types of settlements, the MTM settlement which
happens on a continuous basis at the end of each day, and the final settlement which
happens on the last trading day of the futures contract.
• MTM Settlement for Futures:
All futures contracts for each member are marked-to-market to the daily
settlement plice of the relevant futures contract at the end of each day. The CMs
who have suffered a loss are required to pay the mark-to-market (MTM) loss
amount in cash which is in turn passed on to the CMs who have made a MTM
profit. This is known as daily mark-to-market settlement. CMs are responsible to
collect and settle the daily MTivl profits/losses incurred by the TMs and their
clients clearing and settling through them. Similarly, TMs are responsible to
collect/pay losses/ profits from/to their clients by the next day. The pay-in and
pay-out of the mark-to-market settlement are effected on the day following the
trade day (T + I). After completion of daily settlement computation, all the open
positions are reset to the daily settlement price. Such positions become the open
positions for the next day.
• Final Settlement for Futures:
On the expiry day of the futures contracts, after the close of trading hours,
NSCCL marks all positions of a CM to the final settlement price and the resulting
profit/loss is settled in cash. Final settlement loss/profit amount is debited/credited
to the relevant CM's clearing bank account on the day following expiry day of the
contract.
130
• Settlement Prices for Futures:
Daily settlement price on a trading day is the closing pnce of the respective
futures contracts on such day. The closing price for a futures contract is cUlTently
calculated as the last half an hour weighted average price of the contract in the
F&O Segment of NSE. Pinal settlement price is the closing price of the relevant
underlying index/security in the Capital Market segment of NSE, on the last
trading day of the Contract. The closing price of the underlying Index/security is
currently its last half an hour weighted average value in the Capital Market
Segment of NSE.
4.4.8.2.2 Settlement of Options Contracts on Index or Individual Securities
Options contracts have three types of settlements, daily premium settlement, and interim
exercise settlement in the case of option contracts on securities and final settlement.
• Daily Premium Settlement for Options:
Buyer of an option is obligated to pay the premium towards the options
purchased by him. Similarly, the seller of an option is entitled to receive the
premium for the option sold by him. The premium payable amount and the
premium receivable amount are netted to compute the net premium payable or
receivable amount for each client for each option contract. The CMs who have a
premium payable position arc required to pay the premium amount to NSCCL
which in turn passed on to the members who have a premium receivable position.
This is known as daily premium settlement. CMs are also responsible to collect
and settle for the premium amounts from the TMs and their clients clearing and
settling through them. The pay-in and pay-out of the premium settlement is on
T + I day. The premium payable amount and premium receivable amount are
directly credited/debited to the CMs clearing bank account.
• Interim Exercise Settlement:
Interim exercise settlement takes place only for option contracts on individual
securities. An investor can exercise his in-the-money options at any time during
131
trading hours, through his trading member. Interim exercise settlement is effected
for such options at the close of the trading hours, on the day of exercise, Valid
exercised option contracts arc assigned to short positions in the option contract
with the same series (i.e. having the same underlying. same expiry date and same
strike price). on a random basis. at the client level. The CM who has exercised the
option receives the exercise settlement value per unit of the option from the CM
who has been assigned the option contract.
• Final Exercise Settlement:
Final Exercise settlement is effected for option positions at in-the-money strike
prices existing at the close of trading hours, on the expiration day of an option
contract. All long positions at in-the-money strike prices are automatically
assigned to short positions in option contracts with the same series, on a random
basis. Final settlement loss/prollt amount for option contracts on Index is
debited/credited to the relevant CMs clearing bank account on T + I day. Final
settlement loss/profit amount for option contracts on Individual Securities is
debited/ credited to the relevant CMs clearing bank account on T +2 day. Open
positions, in option contracts, cease to exist after their expiration day.
4.4.9 Risk management system
The salient features of risk containment measures on the F&O segment are:
• Anybody interested in taking membership of F&O segment is required to take
membership of "CM and F&O" or "CM. WDM and F&O". An existing member
of CM segment can also take membership of F&O segment. The details of the
eligibility criteria for membership of F&O segment are given in the chapter on
regulations in this book.
• NSCCL charges an upfront initial margin for all the open positions of a CM up to
client level. It follows the VaR based margining system through SPAN system.
NSCCL computes the initial margin percentage for each Nifty index futures
contract on a daily basis and informs the CMs. The CM in turn collects the initial
margin from the TMs and their respective clients.
132
• NSCCL's on-line position monitoring system monitors a CM's open positions on
a real-time basis. Limits are set for each CM based on his base capital and
additional capital deposited with NSCCL. The on-line position monitoring system
generates alerts whenever a CM reaches a position limit set up by NSCCL.
NSCCL monitors the CMs and TMs for mark to market value violation and for
contract-wise position limit violation.
• CMs are provided with a trading terminal for the purpose of monitoring the open
positions of all the TMs clearing and settling through them. A CM may set
exposure limits for a TM clearing and settling through him. NSCCL assists the
CM to monitor the intra-day exposure limits set up by a CM and whenever a TM
exceeds the limits, it withdraws the trading facility provided to such TM.
• A separate Settlement Guarantee Fund for this segment has been created out of
the capital deposited by the members with NSCCL.
4.4.10 Margins
The margining system for F&O segment is as below:
• Initial margin: Margin in the F&O segment is computed by NSCCL up to client
level for open positions of CMsrrMs. These are required to be paid up-li'ont on
gross basis at individual client level for client positions and on net basis for
proprietary positions. NSCCL collects initial margin for all the open positions of a
CM based on the margins computed by NSE-SPAN. A CM is required to ensure
collection of adequate initial margin from his TMs up-front. The TM is required
to collect adequate initial margins up-front from his clients.
• Premium Margin: In addition to Initial Margin, Premium Margin is charged at
client level. This margin is required to be paid by a buyer of an option till the
premium settlement is complete.
• Assignment IVlargin for Options on Securities: Assignment margin is levied in
addition to initial margin and premium margin. It is required to be paid on
assigned positions of CMs towards interim and final exercise settlement
obligations for option contracts on individual securities, till such obligations are
133
fulfilled. The margin is charged on the net exercise settlement value payable by a
CM towards interim and final exercise settlement.
• Client Margins: NSCCL intimates all members of the margin liability of each of
their client. Additionally members are also required to report details of margins
collected from clients to NSCCL. which holds in trust client margin monies to the
extent reported by the member as having been collected form their respective
clients.
4.4.11 Present scenario of NSE F&O
Following are the observations of NSE F&O market in present circumstances.
• Single-stock futures continue to account for a sizable proportion of the F&O
segment. It constituted 60 per cent of the total turnover during June 2007 A
primary reason attributed to this phenomenon is that traders are comfortable with
single-stock futures than equity options. as the former closely resembles the
erstwhile "Badia" system.
• On relative terms. volumes in the index options segment continue to remain poor.
This may be due to the low volatility of the spot index. Typically. options are
considered more valuable when the volatility of the underlying (in this case, the
index) is high. A related issue is that brokers do not cam high commissions by
recommending index options to their clients, because low volatility leads to
higher waiting time for round-trips.
• Put volumes in the index options and equity options segment have increased since
January 2002. The call-put volumes in index options have decreased from 2.86 in
January 2002 to 1.32 in June 2007. The fall in call-put volumes ratio suggests that
the traders are increasingly becoming pessimistic on the market.
• Farther month futures contracts are still not actively traded. Trading In equity
options on most stocks for even the next month was non-existent.
134
• Daily option price variations suggest that traders use the F&O segment as a less
risky alternative (read substitute) to generate profits from the stock price
movements. The fact that the option premiums tail intra-day stock prices is
evidence to this. If calls and puts arc not looked as just substitutes for spot
trading. the intra-day stock price variations should not have a one-to-one impact
on the option premiums.
Overall NSE is one of the emerging Futures & Options Exchange in the world and
comparison betwcen NSE and rest of the exchanges in the world can be done based
on single stock futures. Index Futures. Single Stock Options and Index Options as
given in the following table.
Tahle-4.7 Comparison of NSE with other World Exchanges in terms of F&O
Instruments
(As on June 20(7)
PrOdth:t S,inglt' Sto, .. k Futures Index Futurt'!Io ~inglt.' Slu" .. k Options Inde" Optinns
:\~E', I ~t \\ Ilh 57~3-e8 10th with 7~~~3: Positinl1 !..':()ntracts -trh with J6~6~~;': re>ntr,)ct5 J -hh wit h -J<)n J 1:< ('(ll1tf";)l'f'-; 1'0ntr;1cl.<:
:\ame of :\UJ11ber :'\umber \umber :"ame of :,\"'uml
the of :\ame of the of :"ame of the of the of Rank EHh;Jll{!t' Contracts Enhangt' COlltrach E'\changt' Contr:ll'l~ E'\chan2t' ('Ullin
,\;)[illn~ll Stol.,-k Chicago Kl'reo Exchan~e \fercantile Stock
t l,f Ind!:! ~ 78:J-C~ F.:'\\.-llJn\~e 29810J.H) S~wr~lIlo ~:'l)-l91(._~ E\(h~lIll:!~ 1c.-l2~:
B\IE , S~"\~ni..;h -l(1.~8)18 Euro;;;\ 1 :<:('2;~)7 Eurl'n~.\t.Lin"c- c~'('11,7 (BOE 1:'(,2:
JSE S~curitlC's
1 Fxch3n,To;;; 2:;;5911 7 Eurl,next.L i n-'e :,:,g9~(d (BOE 21~:'-l-l21 Eurex POO(
135