Futures trading has been in existence in India for almost six months now but contrary to its name, ie, futures trading, it does not give any indication about the future and one wonders whether the figures can be tracked to assess the future direction of the market. On any given day, contracts for one, two and three months have moved in a narrow band and in tandem with the Sensex (see graph: Unable to predict the futures movement of the Sensex).

Thus, if somebody wants to look at the futures index to have a feel of the future movements of the Sensex, he will be disappointed. At this point of time, the movement of all the futures series is dependent on the movement of the index itself. This is basically because of a lack of the speculative element, which brings price efficiency. Today, volumes on the futures market are minuscule and on an average, Rs15-25 cr worth of contracts (all the series together) are traded at both the exchanges, ie, BSE and NSE. Why are the trading volumes so low? What are the hassles?

Today, the Indian futures market is limited to a few market participants, mainly retailers and operators. Institutions are not participating. The major participants are a few retail high networth investors and proprietary traders. Most of the traders are speculators. Few investors are hedging against their cash position though participants are yet to hedge against their underlying portfolio. Because of this, the depth of the market is not leading to higher spreads and low liquidity is a result. One reason for this is the limited understanding of the product. It will take some time before participants understand the beauty of the product as far as hedging and speculation are concerned. Meanwhile, BSE and NSE are taking steps to spread awareness about the product.

Till date, the BSE has conducted fifty ‘basic programmes on derivatives’ (it covers introduction to derivatives, index futures, options, regulatory aspects of the derivatives market, taxation aspects and margin calculations) to increase investor awareness and develop an understanding of the product. Both BSE and NSE conduct certification test programmes in the derivatives core module, which as per SEBI guidelines is mandatory for every broking house planning to trade in derivatives.

But there are some hurdles which deter the Indian futures markets from gaining depth and fund participation. Capital account convertibility is one of the handicaps. It may prevent some of the bigger hedge funds from entering the market. FII margin money with the underlying currency risk is one of the deterrents. Says Paran Das, AVP, retail broking, Motilal Oswal Securities, “FIIs have to pay margin money, which carries currency risk. Since the rupee is volatile, they are afraid that it will not be appropriate to take currency risk. The margin money is to be paid in rupees.” Mutual funds have to take permission from their trustees to participate in the derivatives market. They also have to take an investors’ resolution before participating in the derivatives market.

Market players say Sebi should actively encourage FIIs to participate in such products.The concept of hedging should be promoted among domestic institutions like UTI, LIC and GIC.

Poor liquidity has resulted in high spreads, further deterring participants. Says Paran Das, “The spread is wide because of low liquidity. The far month contracts are extremely illiquid. Sebi and RBI should ensure smooth participation of FIIs and domestic institutions to increase volumes and hence liquidity.”

What can be done to develop the Indian futures market? Sanjiv Shah, SVP, DSP Merrill Lynch, says, “Markets can gain more depth and participation in two ways. One is the ability of institutions to trade without restriction in terms of only hedging, and second is the inexpensive way to sell short in the underlying cash market.”

There can be big players in this market as they have a huge underlying portfolio to hedge. Moreover, there should be various education programmes to increase the awareness about futures products.

But on the positive side, though the volumes are still very low, the trends of the overall turnover and number of futures contract traded on BSE and NSE are quite encouraging. Since the launch of the index futures, both the exchanges are expanding their lists of trading and clearing members, which is indicative of the arena getting heated up (see table: Moving at snail’s pace).

At BSE, the daily average volume in Nov. 2000 alone has been around Rs 9 cr. It was Rs 4 cr during June 2000. Same is the trend on NSE, where the daily average volume improved to Rs 11 cr during Nov. 2000 from just Rs 2 cr in Jun. 2000. This is mainly due to higher number of average daily contracts traded, which, on BSE, rose to nearly 450 contracts in Nov. 2000 from 150 in Jun. 2000, and at NSE it rose to 443 contracts from 74 during the period.

The healthy trend of higher levels of open interest on both BSE and NSE, month after month, displays increased trust on the trading system and points towards the fact that more players want to hold their positions till maturity. Market circles expect that once the rolling settlement is expanded to A group shares, as the watch dog seems committed to do so, it will boost futures market volumes to a great extent and provide an added impetus.