Impact of SEBI allowing physical delivery in derivatives

Seminar (Training programme) in Coimbatore on Techno-fundamental in Tamil by A.K.Prabhakar on 13/March/2010 Saturday 9.00-5.30 http://akprabhakar.blogspot.com/2010/03/seminar-in-coimbatore-on-techno.html

Currently Indian stock markets we follow cash settlement system where on the last day of the contract average closing price is the squaring-off value and based on that contract are squared. Where traders manipulate prices by taking large short positions in the futures market near contract expiry and then depress the formula-based settlement price, thus making a windfall on futures positions.

Physical settlement of equities is when an underlying stock is purchased from the cash market and delivered to the counter-party for a specified payment when the contract expires. Chances of manipulation are greater in cash settlement in the absence of physical settlement system. Once such a system is in place, manipulators would know that if they artificially increase or decrease stock prices, counter parties could impose delivery.

http://www.investopedia.com/terms/c/cashsettlement.asp

The Chicago Board of Trade, from where futures and options originated, has physical settlement of derivatives trade and most developed markets in the world follow the same practice. India introduced a system in phased manner so that market is mature enough to adapt to the changes.

Benefits: Volumes in Cash segment would improve, now situation is Cash to Derivative volumes are 1:8 ratio which is keeping Indian market most volatile. As we have mentioned before in one of our article Indian market saw extreme correction in 2008 and extreme recovery in 2009 years of contrasts and any move to link F&O to delivery is positive for market in long run.

Risk factors: Many traders in Indian market don’t understand the risk factor in present simple system and if delivery of option is introduced then immature option writers can face huge risk.

I A.K.Prabhakar has always been against derivative trade and if this system is introduced it is very healthy for Indian market as market would have more stability but small & immature traders would be eradicated if they don’t do their homework well http://akprabhakar.blogspot.com/2010/01/f-trading-futures-that-can-drains-your.html