Margin Trading: Small Investors Will Gain

Updated: Sep 21 2003, 05:30am hrs
There are lingering doubts in some quarters about the desirability of introduction of margin trading mainly due to the tremendous success of trading in derivatives, volumes in respect of which are presently almost double the volumes in the cash segment, as is the general trend in many of the global markets.

There need be no surprise that trading in futures and options is a success in India, as trading in futures is almost akin to badla trading, which has been the hallmark of trading in Indian stock markets. There need be equally no surprise about the success in trading in options, as there used to be a regular options market with several variants called by names like teji, mandi, phatak, nazrana, etc despite the fact that it was illegal till 2000. James M Maclean, editor of the Bombay Gazette, who later became a Member of British Parliament, observed way back in 1899 that "India being the original home of options, a native broker would give a few points to the brokers of the other nations in the manipulation of puts and calls." Such was the expertise and acumen of the Indian brokers.

Futures and options have proved to be excellent instruments not merely for price discovery and hedging, but also for arbitrage between futures and cash, between futures and options, between options and cash and between different deliveries in futures interse as also between different strike points in options interse, helping in better market efficiency and price discovery. Besides, futures can also conveniently be deployed as an instrument to park funds and realise interest as a money market instrument as also to raise cash against securities for short periods, as used to be done through badla trading. In fact, futures has proved to be a better instrument than badla, since a futures contract puts both buyers and sellers on an equal footing while badla used to be tilted in favour of sellers, as short sellers were also entitled for contango.

With all the advantages that futures and options undoubtedly have, small investors are just unable to participate in these instruments not merely because of the tremendous complexities involved in these instruments, but also due to the high cost involved.

A futures or options contract is worth Rs 2 lakh and the margin amount itself varies from 10 per cent to 40 per cent. In the case of options, risk is too high for an ordinary investor to be a writer and a buyer of call or put options is invariably a loser. Moreover, futures and options are confined to only 54 stocks besides Sensex and Nifty.

If the small investors of the country have to take advantage of the growing opportunities in the Indian securities market, the only instrument which can give them some leverage is margin trading. Even with a margin of 50 per cent, he can have leverage of 2 multiple points.

In other words, with just say Rs 10,000 he can acquire stocks worth Rs 20,000 and double his likely profits. If the price of a security rises by say, 25 per cent, without the facility of margin trading, his profit on his investment of Rs 10,000 would be Rs 2,500 while his profit on his investment of Rs 10,000 would be Rs 5,000 with margin trading. There is also, of course, the attendant risk of incurring the losses twice as much in case of a fall in price. This is for the investor to decide.

Introduction of margin trading has other attendant advantages too. There will be an improvement in liquidity in a wide spectrum of securities (which is woefully lacking at present), as the facility of margin trading can be extended not only to 198 scrips in the A group but also to several others in the B1 group.

One can hold on to the securities for a much longer period and need not bother about short-term volatility in the market, subject of course to maintenance of minimum margin.

This, incidentally, will in turn help in reducing short term volatility in the market. In order to grant greater leverage, the minimum margin can be fixed at say, 40 per cent instead of 50 per cent. This would give a leverage of 2.5 multiples.

The only care that needs to be taken before introduction of margin trading is to ensure that the financing arrangements have to be fool-proof.

Banks and NBFCs can, no doubt, provide the required finance. Banks, which have been hesitant in the matter, need to be induced to undertake this activity within the limits set by the RBI.

Besides, corporate stock brokers with a networth of say, at least Rs 25 crore, can also be permitted to undertake this activity through a separate subsidiary, subject to adequate prudential norms.

Margin trading is a well-accepted instrument in all the developed markets of the world. There is no reason why India, whose framework of the market is better than those of several developed markets, should lag behind in margin trading, particularly so because it is in the interest of small investors.

(The author is the chairman of Inter-Connected Stock Exchange of India Ltd. These are his personal views)