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Options traders pray for volatile times

Indian stock exchanges have freed the way for the introduction of sophisticated derivatives but volumes could be higher if it was not for the absence of a key element -- volatility.

A prolonged spell of flat trading has meant that there is reduced appetite for hedging, and as a result, trading in options contracts has not yet taken off in a big way.

But observers say it is only a matter of time before volumes pick up as Indian traders are learning the ropes fast.

"In less than a month's time, the market-place has transformed from traders understanding the basics of options trade to adopting strategies like straddles and strangles," said Vineet Bhatnagar, managing director at Refco-Sify Securities India.

A "straddle" is a strategy involving call and put options with identical strike prices and expiration dates. A "strangle" involves puts and calls with the same expiration dates but at different prices.

In both cases, the holder of the contracts is betting that there will be large price movements but is uncertain about the direction.

The Securities and Exchange Board of India allowed domestic bourses to offer options trading in 31 select stocks from July 2 as a hedging tool to replace the century-old carry-forward facility.

Carry-forward was abolished despite its popularity after it was blamed for a stock market payment crisis and for triggering a stock slide in March this year.

At its peak the facility accounted for around 90 per cent of trades on domestic bourses. The system allowed investors to keep positions open from one settlement period to the next by paying an interest charge giving them more leeway to speculate.

LOW VOLUMES, RANGED MARKET

Narrow movements in the stock market, however, was restricting traders and limiting volumes, brokers said.

"In a range-bound market one cannot devise aggressive strategies," said Vikas Khemani, assistant vice-president at ICICI Securities and Finance Company Ltd.

Since options trade in individual shares began on July 2, the benchmark 30-stock Bombay index has traded in a 3,300-3,500-point band.

The number of contracts traded in individual stock options at the National Stock Exchange rose to 1,149 contracts on July 26 from 379 contracts on the first day.

Khemani said that in a sideways market traders should adopt the butterfly spreads options strategy, which provides potential gains if the underlying security is stable and at the same time results in a small loss if the underlying moves dramatically.

Analysts said that since it was early days yet, traders were still trying to arrive at the ideal price discovery mechanism.

"The out-of-the-money options are underpriced whereas those which are at the money are slightly overpriced," said Deepak Mohoni, analyst at trendwatchindia.com.

Another analyst said the premium was mis-priced in some cases because the stock price volatility factored in was inaccurate.

"The box spread strategy is a fool-proof arbitrage opportunity given the premium mispricing," said Devangshu Datta, an independent New Delhi-based analyst.

The box strategy is a combination of a bull spread and a bear spread on the same underlying security, which will trigger two options when the stock price moves in either direction.

These spreads are created on the same underlying security and have the same expiry date.

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