The problem with physical delivery is that it is close to impossible to short-sell a stock in the Indian market. We have seen this in the cash segment. While a short-selling mechanism exists in theory, shorting stocks outside the F&O segment, except in day trades is impractical.
The short-seller must borrow stocks from some institution that holds it in the portfolio. This involves first, the willingness of such an institution to lend stock. It also involves paying interest, and having to buyback from the market to replace the stock and complete the trade.
The inability to short sell stocks in the cash segment causes less efficient price discovery. In stocks with low free-float, it can lead to a situation where trading stops, with near-zero volume and quotes that fail to reflect changes in the corporate's business situation. It can also lead to short-squeezes as in the bad old days of badla, where short-sellers cannot cover a trade. That is a classic manipulative situation where institutions with large holdings can control the price of a share.
The F&O segment was created to avoid such inefficiencies in large caps. This system has worked quite well. The premium/ discount between futures and cash prices are generally close to the cost of carry. By forcing physical settlement, the distinctions between cash segment and F&O are being reduced.
The likely result will be a reduction in volumes across cash and derivatives segment and a rise in bid-ask spreads. Impact costs are bound to rise. Institutions and large investors, which hold large portfolios of underlying stocks will also have an enhanced power to manipulate prices since they will effectively be the only short-players.
http://www.business-standard.com/ar...very-of-stock-derivatives-118042300171_1.html
The short-seller must borrow stocks from some institution that holds it in the portfolio. This involves first, the willingness of such an institution to lend stock. It also involves paying interest, and having to buyback from the market to replace the stock and complete the trade.
The inability to short sell stocks in the cash segment causes less efficient price discovery. In stocks with low free-float, it can lead to a situation where trading stops, with near-zero volume and quotes that fail to reflect changes in the corporate's business situation. It can also lead to short-squeezes as in the bad old days of badla, where short-sellers cannot cover a trade. That is a classic manipulative situation where institutions with large holdings can control the price of a share.
The F&O segment was created to avoid such inefficiencies in large caps. This system has worked quite well. The premium/ discount between futures and cash prices are generally close to the cost of carry. By forcing physical settlement, the distinctions between cash segment and F&O are being reduced.
The likely result will be a reduction in volumes across cash and derivatives segment and a rise in bid-ask spreads. Impact costs are bound to rise. Institutions and large investors, which hold large portfolios of underlying stocks will also have an enhanced power to manipulate prices since they will effectively be the only short-players.
http://www.business-standard.com/ar...very-of-stock-derivatives-118042300171_1.html
1. It's not like SEBI is banning derivatives, they're just introducing physical settlements. Those who want to square off their short trades before expiry surely can to avoid the risk of a short-squeeze and physical delivery.
2. Those old days are long gone because when stock derivatives were introduced, they knew this and have taken precaution by reducing chances of such manipulations by introducing position limits on the client level and broker level. They also have open interest limits and market-wide limits. The banned scrip mechanism works perfectly as stocks which have breached their limits will not be allowed fresh positions etc. These are measures which will continue even as we move from cash settlement to physical settlements.
3. So far the derivatives segment is designed more for the speculators than hedgers/arbitrageurs. Now, it's going to become a level playing field for all types of market participants. In developed markets such as the US, physical settlements is the norm so it's a natural progression.
4. One of the reasons Stock Lending & Borrowing has not taken off is because speculators/traders don't have a reason to borrow stocks and hence there was no demand for that at all so an eco-system never developed around that requirement. Physical settlement is a cornerstone which can really bolster the demand for it. When there is money to be made and retail traders can participate by wanting to borrow stocks, then even small investors won't mind lending them. This way the market will evolve to include smaller players too.
These are my strong opinions and I reserve the right to be wrong