In a move that will be closely watched by other bourses, the Bombay Stock Exchange (BSE) has decided to introduce delivery-based stock futures and options contracts (F&O) from February. The move comes six months after the capital market regulator gave the go-ahead for delivery-based stock derivatives.

“Effective February 1, trading on all existing single stock F&O contracts expiring on or after April 13, 2011, will be delivery-based,” said a BSE circular released on Monday. “All single stock F&O contracts expiring on February 10 and March 17 will continue to be cash-settled. There will be no change in other contract specifications like size, strike intervals, number of strikes for options, expiry day, and calculation of settlement price. Final settlement will be on expiry + three business days,” added the circular.

This has been a long-standing demand of a large section of market players which feels the current practice of cash settlement leads to excessive speculation.

Under the delivery-based system, also known as physical settlement, the contracts have to be settled with the underlying stocks instead of cash. Many believe since the contracts are currently settled in cash, there is a disconnect between prices in spot and derivatives markets.

The National Stock Exchange, which has a monopoly in the equity derivatives segment, has continued with the cash settlement mechanism in the derivatives arena. It has, however, switched to the European style of contracts, wherein the contract can be squared off only on the day of expiry (maturity).

Experts say it is a bit too early to comment whether delivery-based stock derivatives will manage to generate volumes. The initial response needs to be looked at, they add.

“The initial response to the physical settlement in stock F&O is likely to be lukewarm. However, volumes should pick up gradually,” said K Subramanyam, AVP – institutional clients (derivatives), Asit C Mehta Investment Intermediaries.

“The introduction of physical settlement in stock F&O might be the trigger to boost volume in stock lending and borrowing (SLB) mechanism as well,” he added.

The SLB mechanism will indeed play a crucial role in the development of delivery-based stock F&O contracts. For long, it has been said there is no robust SLB market in India. Hence, delivery-based equity derivatives cannot be introduced. Interestingly, a section of analysts believes SLB will take off automatically once delivery-based derivatives are allowed.

“Unless the SLB mechanism takes off in India, physical settlement in stock futures and options may not work,” said T S Harihar, co-head (Institutional Derivatives), ICICI Securities. “At present, people are not finding SLB lucrative,” he added.

source: Business Standard

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