Patterns in Trading Volume of Different Derivative Instruments in Indian Stock Market A Study with Reference to NSE & BSE

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1 International Journal of Accounting & Business Management Vol. 2 (No.1), April, 2014 Page: ISSN: This work is licensed under a Creative Commons Attribution 4.0 International License. Research Paper Patterns in Trading Volume of Different Derivative Instruments in Indian Stock Market A Study with Reference to NSE & BSE R. Karthik Research Scholar, Sathyabama University Chennai, India Karthik_589@yahoo.com Dr. N. Kannan Supervisor, Sathyabama University Chennai, India Kannu74@yahoo.co.in Abstract During the last three decades there has been enormous growth in derivative trading all over the world. New products with finer specifications are being developed. Today derivative instruments are available in almost every area such as forex, commodities, interest rate, stock market, bank credit or even weather. In India the growth of derivative segment in organized exchanges has taken place in last decade only. Today, derivatives are not only used by large companies having skilled financial engineers rather these products are being used even by small common investors. India is among few countries where growth of individual stock market derivative trading has been phenomenal. Since inception of derivative segment in India some clear patterns of different derivative products can be observed. World over different surveys have been conducted such as IOMA/WFE, DRIS (HKEx) etc. These surveys have also shown different patterns in derivative trading. This paper attempts to study the patterns in trading volume of different derivative products and investor s preferences in Indian stock market. Keywords: Futures, Options, Put Option, Call option, Stock and Index Derivatives 1. Derivative products in Indian Stock Market The growth of derivative trading in India has been phenomenal in the last one decade. Trading in Derivatives instruments in India started in 2000 with the launch of index future in June 2000 and subsequently index option in June History was created in July 2001 when India became one of those few countries where derivatives on individual securities are allowed. Options in select 31 individual securities started in July 2001 and futures on individual securities started in November Derivatives are the instruments or securities which derive their value from some underlying assets. These underlying assets may be commodities, shares of companies, benchmark index, currency etc. Thus derivative instruments are available in almost all walks of life. As such the financial derivatives are financial instruments whose prices or values are derived from the prices of other underlying financial instruments or financial assets. The underlying financial instruments may be an equity share, stock, bond, debenture, treasury bill, foreign currency or even another derivative asset. Similarly, the value of a treasury bill of futures contracts or foreign currency forward contract will depend upon the price or value of the underlying assets, such as Treasury bill or foreign currency. In other words, the price of the derivative is not arbitrary rather it is linked or affected to the prices of the underlying asset that will automatically affect to offset the risk of price change in the underlying assets. Different ISSN: Page 103

2 types of derivatives are traded in different markets for example commodity derivatives are traded in commodity exchanges such as MCX, NCDEX etc and stock derivatives in BSE/NSE etc. In Indian stock market mainly the following four types of products are traded: Index futures: Index futures are futures where underlying is some benchmark stock exchange indices such as Nifty, Mini Nifty, S & P CNX Nifty, Sensex, Mini Sensex etc. These Products are based on overall performance of that Index. In Both NSE and BSE these products are very popular. Index Options: Options are the products where buyer can buy the option (on some index) to buy (call) or sell (Put) the underlying Index at a predetermined rate in specified period. Stock futures: India is among few countries where individual securities futures are available. Stock futures are available on 224 and 89 securities at NSE and BSE respectively. Stock futures are futures on individual stocks of companies for one, two or three month s period. Stock options: Stock options are Put or Call option on selected tock (224 and 89 at NSE and BSE respectively). 2. Review of literature Subramaniam and Rao (2008) suggested use of one month volume based protective put option strategy because it provide better re ults than any other option strategy. These results are more profound in bearish market than bullish market. Ramanjaneyalu and Hosamani (2008) surveyed investors to kno their views about Derivative segment as there are lot of myths about derivative segment among participants. Study revealed that majority of investors (62%) assumes that derivative instruments are meant for speculation thus they are ignorant of the main purpose of derivatives that is risk hedging. More than 50% investors take derivatives as new complex and hi tech products in reality these products can be easily used with some orientation. With this study one can understand need of orientation of common investors towards derivatives products as risk hedging tool. Sarkar (2006) has highlighted that retail investors were the major participants (60%) in equity derivatives segment of SE in He highlighted the success of stock derivatives in India among few countries in the whole world and indicated experience of Indian investors in 'Badla System' as the major reason for the success of stock derivative. Small size of the futures contracts, compared to similar contracts in other countries was highlighted as another reason for the success of stock futures in India. Debasis (2008 ) confirmed, in his study of lead lag analysis in future and pot market, co integration and lead lag relationship between pot and futures market in Indian stock market. It w observed that futures market plays price discovery role in market. Futures markets are more efficient than spot market in reflecting new information and spot market follow the same. Indian traders buy and sell stocks rather than index future and they exploit information about future trend from future market. Mittal and Sharma (2004) mentioned the order in which derivative instrument are popular. Derivatives instruments were popular in this order: first, Stock future second, Index future Third, Stock option forth, Index options. It was found that futures were more popular than options and stocks were more popular to index. ISSN: Page 104

3 Sahoo, (2004) Explained that NSE provides a fully automated screen based trading for options and futures. It provides tremendous flexibility to users in terms of kind of orders to be placed on the system. Kumar Naresh (1995) explained need to understand risks associated with index options because index options are settled in cash and underlying market is not available in this case. 2.1 Objective of the study: Since the launch of derivative segment in Indian stock market a specific pattern in trading volume of different derivative products i.e. index futures, index options, stock futures and stock options have been observed. At international level also volume of different stock market derivatives are different. This paper aims to study specific patterns of volumes of trading in various products such as Future vs Option, Stock vs Index and Call vs put in derivative segment of Indian stock market. 3. Research Design and Methods To study pattern of trading volume of various derivative instruments both primary and secondary data has been used. In order to test variation in the use of various derivatives instruments one way ANOVA test has been applied. To apply ANOVA test, data of monthly turnover of various derivative instruments at NSE for 77 months from June 2004 to March 2013 was taken from NSE (because NSE accounts for more around 99% derivative trading). Primary data of 200 investors has also been studied to verify national trends and reasons for the same. 4. Results and Discussion It can be observed (from table no. 4 - one way ANOVA output) that value of F i.e is significant at 1 % level of significance. Thus Null hypothesis is rejected. That means there is no variation in the trading volume of four derivative instruments i.e. stock futures, Index futures, Stock option and Index option. Thus it can be implied that there is significant variation in investment pattern off our derivative instruments. This can be clearly verified from table no.3 and 5.This fact is also seen in some international surveys such as IOMAIWFE, DRIS (HKEx) etc. It is observed (from table no. 3 and Figure no. 1,2,3 and 4) that individual stock derivative instrument has been more popular than index derivatives (in both futures and options) It may be due to the fact that individual stock derivative are simple to understand by common investor and they are familiar with earlier 'Badla system' in stock market. Index products seems an abstract thing for the investors. It is easy to predict one company's expected performance as compared to performance of the whole economy. But from the year this trend has changed and index products have surpassed individual stock products because share of Index products has increased from 26% in to 41 % in and 66% in This fact can also be verified through primary data (Table no.5) It can be inferred that market has become mature and investors awareness about index products is increasing over the period of time. It may also happen because now FIls are actively trading in index derivatives. It can be observed (from table no. 3 and figure no. 1,2,3 and 4) that Futures are more popular than options. Share of futures in total trading volume has been 72% and 88% for and respectively. There may be few reasons such as first, in options contracts upfront option premium is to be paid which is a high cost factor as compared to futures contracts. In futures contract only margin amount is payable which is refundable after mark to market adjustments. Second, there is less ISSN: Page 105

4 liquidity in option segment. Third, futures are simple to understand as compared to options contracts. But in share of futures in total trading volume has declined to only 64%. It shows that our derivative traders have matured in option applications. It can be observed (from table no. 3 and figure no. 5 and 6) that call options are more popular than Put options. This fact can also be verified from primary data (table no. 8) that respondents prefer more of call trading than put. It signifies that investors prefer long position than short positions. This approach can be seen as bullish attitude of investors in Indian capital market. It is also observed that call put ratio has been high in stock option segment as compared to Index option segment i.e. call- put ratio has been 4: I in individual stock segment as compared to around I: 1 in Index segment. Over the years this ratio has declined and in the year this ratio had reduced to around one. Table no. 1 and 2 on Derivative trading explain that from the year maximum trading is done at NSE. In the year derivative trading has been almost negligible at BSE. Afterwards BSE aggressively launched promotional campaign. Thus, from the year BSE has taken up the trading successfully in futures segment. At BSE option segment trading i almost negligible. But again in share of BSE in derivative turnover is less than 1 percent. Thus virtually the whole derivative trading is done at NSE. 5. Conclusion Since the launch of derivative trading in Indian stock market, there has been Specific pattern in trading volume of different derivative products. Futures products have been more popular than options products. But over the years Indian trader has matured and options share has increased from negligible share in Individual stock instruments have been more popular than index products but recently this trend has changed. Thus now traders are well acquainted with index base products. This may also be due to launch of Mini Products. Over the period high call put ratio has also declined significantly which may be due to institutional investor s involvement in the market. References Booth, GGeoffrey, Ji-Chai Lin, Teppo Martikainen, and Yiuman Tse, (2002). Trading and pricing in upstairs and downstairs stock markets, Review of Financial Studies 15, III Chakravarty, Sugato, Huseyin Gulen, & Stewart Mayhew. (2004). Informed trading in stock and option markets. Journal of fmance, 54(3): Gupta, S.L., Financial Derivatives: theory concepts and problems Prentice hall of India Private Limited ew Delhi Hull, John C., Option, futures, and other derivatives, Pearson Education (Singapore) pte. Ltd., Delhi Mayhew S. (2000). The impact of derivatives on cash markets: What have learned? University of Georgia working paper. Ramanjaneyalu N, Hossamani A P( 2008) Financial Derivatives: Myths and reality, Indian Journal of Finance, pp Stoll, Hans R. and Robert E. Whaley, (1990). The Dynamics of Stock Index and Stock Index Futures Returns, Journal of Quantitative and Financial Analysis 25, Thenmozhi M. (2002). Futures Trading, Information and Spot Price Volatility of SE-50 Index Futures Contract, NSE Research Paper, SE India. Thenmozhi M. (2002). Futures Trading, Information and Spot Price Volatility of SE-50 Index Futures Contract, NSE Research Paper, SE India. ISSN: Page 106

5 Appendix Year Index futures Stock futures ( Rs. Crore) Index option Stock option Total Call put Call put June 04 March (Source: Table 1: Turnover of Derivative Segment at NSE Year Index futures Stock futures Index option Stock option Total Call put Call put June 04 March (Source: Table 2: Turnover of Derivative Segment at BSE ( Rs. Crore) Year Index Stock Index option Stock option Total futures futures Call put Call put June 04 March Table 3: Product wi e Turnover of Derivatives Instruments in India (Combined Turnover of BSE and NSE) ISSN: Page 107

6 Sum of square DF Mean Square F Significance Between Groups 2.10E E+ll Within Group 5.29E E+1O Total 7.39E (Hypothesis (HO): There is no variation in the trading pattern of the investors among four instruments i.e. stock futures, Index futures, Stock option and Index option.) Table 4: One way ANOVA Test Output between and within F& O Product In which type of Derivative instrument do you trade? No. of respondent Percentage Securities Futures Securities Option Index Futures Index Option All of above (Multiple answer were allowed thus total of % age may not add to 100) Table 5: Type of Derivative Instrument Traded by Respondents Do you prefer futures over options? No. of respondents Percentage Yes No Table 6: Preference of Futures over Options Do you prefer options over futures? No. of respondents Percentage Yes No Table 7: Preference of Options over Futures Which type of Option contract do you prefer? No. of respondents Percentage Put Call (Multiple answer were allowed thus total of % age may not add to 100) Table 8: Preference of Call option over Put option ISSN: Page 108

7 Figure 1: Share of different Derivative instruments in India Figure 2: Share of different Derivative instruments in India ISSN: Page 109

8 Figure 3: Share of different Derivative instruments in India Figure 4: Share of different Derivative instruments in India ISSN: Page 110

9 Call vs Put option Figure 5: Share of trading volume: Call vs Put Options Call vs put option Figure 6: Share of trading volume: Call vs Put Options ISSN: Page 111