India’s options market is growing at the fastest pace in the world, helping restore investor confidence in a stock market yet to recover from a 52 percent plunge during the global financial crisis.
Equity options traded on the National Stock Exchange of India Ltd. rose 36 percent in the first half, the most among the 10 largest bourses, according to the World Federation of Exchanges. The BSE India Sensitive Index’s volatility has dropped below measures in Brazil, Russia and China to the lowest level since at least 1993, data compiled by Bloomberg show.
Foreigners bought a net $21 billion of local equities this year, pushing the Sensex (SENSEX) up 26 percent, the most of the so- called BRIC markets. While the increase in options reflects speculation by Indian investors, it also provides international money managers with the opportunity to hedge their bets. In 2008, when the crisis sparked a record plunge in the Sensex, options trading was 92 percent below today’s level.
“Indian options have given sophisticated investors the flexibility to protect themselves from volatility and also profit from it,” Manoj Murlidharan Vayalar, the associate vice president of derivatives at India Infoline Ltd. (IIFL), said in a phone interview on Dec. 7 from Mumbai.
Options trading may grow at a 20 percent annual pace during the next four years as Asia’s fifth-biggest equity market matures, said Rakesh Somani, the president of the Association of National Exchanges Members of India and a director at Eureka Stock & Share Broking Services Ltd., in a Nov. 23 interview. Options give investors the right, without the obligation, to buy or sell assets at a fixed price by a specific date.
The Sensex fell 0.1 percent to 19,409.69 at the 3:30 p.m. close in Mumbai, after changing directions at least 19 times.
Options volumes began rising in 2008 after the government reduced taxes on the contracts. Trading on the NSE and BSE Ltd.’s bourse in Mumbai exploded to a notional value of about $468 billion in October, or about eight times the value of traded shares, data compiled by the WFE and Bloomberg show. In Brazil, the value of options was about twice that of stocks. A total 23.7 million equity options traded on the NSE in the first six months of 2012.
Average daily trading in options of Mumbai-based State Bank of India (SBIN), the nation’s largest lender, climbed to about 74,000 contracts in November from 2,200 four years ago, according to data compiled by Bloomberg. Volumes for Bangalore-based Infosys Ltd. (INFY:US), India’s second-largest software services exporter, increased to about 14,000 from 800.
“Options are wonderful instruments as they add to the liquidity, functionality and trading choices,” Sunil Singhania, who helps oversee about $16 billion as the head of equities at Mumbai-based Reliance Capital Asset Management Ltd., India’s second-biggest mutual fund manager, said in an interview at his office on Dec. 7. The growing market “attracts long-term money from both India and abroad.”
Options trading has hurt India’s capital markets by encouraging speculation instead of long-term equity investment, said Jignesh Shah, the vice chairman of MCX Stock Exchange Ltd., which plans to start trading stocks and equity derivatives next year.
The 30-day average value of shares traded on the NSE and BSE has dropped to the equivalent of about $2.4 billion from $4.6 billion three years ago, data compiled by Bloomberg show.
“Giving excessive focus on a single segment like derivatives and a few speculative products has caused great harm to the overall balance of Indian capital markets,” Shah said in an interview in Mumbai on Nov. 19. “The fundamental approach we have is to create an investment culture.”
India’s stock market regulator prevented the creation of so-called mini-derivatives linked to the Nifty and Sensex indexes last month. The Nov. 20 ban is meant to keep individuals from trading the securities, which have a smaller notional value than standard contracts, the Securities & Exchange Board of India said in the order.
“Small investors were not aware of the various nuances and the fact that mini-derivatives were leveraged products,” SEBI Chairman U.K. Sinha said in Mumbai on Nov. 23. “But by no means should options be done away with. Derivatives are not weapons of mass destruction. They serve a legitimate function of providing liquidity and hedging risks.”
The growth is prompting brokerages that dominate trading to shift staff.
Religare Capital Markets Ltd. has moved employees to its options business from equities this year, said Gautam Trivedi, the head of equities at the unit of Religare Enterprises Ltd. (RELG), the nation’s largest securities firm by market value. Motilal Oswal Financial Services Ltd. (MOFS) is increasing options training for research and sales staff, said Sameer Kamath, the chief financial officer at the Mumbai-based broker.
“Domestic brokerages are increasingly selling more derivatives products to offshore clients,” said R.K. Gupta, who helps oversee about $645 million as a New Delhi-based managing director at Taurus Asset Management Ltd.
Foreign purchases of Indian shares this year were the biggest among 10 Asian markets tracked by Bloomberg. The Sensex index is valued at 16 times reported earnings, compared with 20 for Brazil’s Bovespa Index, 11 for China’s Shanghai Composite Index and 5.8 for Russia’s Micex Index.
Options are also becoming more popular because they allow speculators to leverage bets, according to Gupta. Options typically cost a fraction of stocks and prices for contracts approaching expiration often fluctuate more than the underlying shares, data compiled by Bloomberg show.
Call options that expire this month on Reliance Industries Ltd. (RIL), India’s largest company by market value, traded at 15.4 rupees on Nov. 20. The contracts, which have a strike price of 780 rupees, jumped 15 percent to 17.65 rupees the next day as the underlying shares gained 0.8 percent to 771 rupees.
The 90-day historical volatility of the Sensex fell to a record 11.46 today, data compiled by Bloomberg show. Brazil’s Bovespa has a volatility reading of 20, versus 16 for the Micex and the Shanghai Composite, and 11.7 for the Standard & Poor’s 500 Index.
The India VIX, a measure of options prices, dropped to a record 13.04 on Oct. 22. The gauge fell for a third day today, losing 3 percent to 14.51 at 4:31 p.m. today.
Dalton Capital Advisors India Pvt., a unit of London-based Dalton Strategic Partnership LLP, buys options to protect stock holdings from declines before market-moving events. The contracts are cheap after a drop in volatility, U.R. Bhat, a Mumbai-based managing director at Dalton Capital, whose parent has $2 billion of global assets, said by phone on Dec. 7.
“Most institutions are increasingly using more options,” Bhat said. “Growth of the options market has been aided by a rise in liquidity.”
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