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Punt with Options; Roll with Rolling Settlement

While the transition may not be a smooth, the new order will certainly be a big leap towards globalisation of domestic bourses

Amid an undertone of uncertainty and caution, the BSE bid a rather firm adieu to the age-old carry forward system. Taking off on a rather jittery note, the BSE Sensex plunged by 63 points, as outstanding positions were unwounded ahead of the July 2 deadline. However FIIs came to the rescue of the markets, buying in to technology and old economy favourites. Buoyed by impressive institutional buying, the sentiment turned around with the Sensex closing the week with a net gain of 2.22% at 3456.78.

Monday will herald the beginning of a new era on the Indian markets in more than one way. Starting July 2, a fresh lot of 251 stocks will join the rolling settlement mode, taking the total tally to 414. Under the new dispensation, investors will have to square off their positions on the transaction day or enter in to a delivery-based settlement. With stocks in the rolling mode accounting for 90-95% of trading volumes, this is likely to rein in the speculative excesses that has debilitated the markets in recent times.

Going a step further, the regulator has substituted the carry forward system with a range of alternative speculative and hedging alternatives. Thus, Indian markets will be on par with their global counterparts. In addition to index futures and index options, investors can now hedge their positions in a select bundle of 31 stocks through stock options. While the choice is still narrow, the list will expand as the market adapts to the new generation products.

In a bid to reign in volatility, the market regulator has also imposed index based and stock based circuits. The index based circuit breaker system will be applicable at three stages. In the event of the BSE or NSE moving by 10%, 15% and 20% either way, the circuit breakers will trigger a simultaneous trading halt in all equity and equity derivative markets nationwide. In addition, there is a 20% price band (either way) for stocks that are into compulsory rolling settlement.

Even as the market regulator has set the framework in order, the transition is expected to be far from smooth. Index futures, which has been around for a while now is yet to attract healthy interest. To add to the list of woes, FIIs, who hold the vast experience of trading in the derivatives market, have been constrained by the lack of regulatory clarity on their participation. On the other hand, domestic players lack prior experience. Thus, it's a catch-22 situation.


Outlook

The new order will certainly be a big leap towards globalisation of the domestic bourses. While the system would certainly go a long way in improving the health of the market in the long run, the transition will certainly see some glitches. With lack of experience and skepticism built around it, markets are likely to stay volatile. Add to it, with UTI scheduled for its annual board meeting on Monday to decide the dividend on Unit Scheme '64 , any signs of a trouble in its flagship scheme could compound market's problems.