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By international standards, they were small markets. They had roughly equal market share. Derivatives trading, which started in June , was a turning point in many ways. The size of the spot and the derivatives business was qualitatively transformed as a consequence.
And after all these changes had fallen into place, NSE and BSE were both amongst the top 10 exchanges of the world, measured by the number of transactions. In this article, we look more closely at the experience of NSE with derivatives trading, analysing the sub-components of turnover, measured in contracts per month. This is admittedly an imperfect measure, because all contracts are not identically sized. At the same time, this analysis does yield useful insights into the evolution of NSE.
Derivatives trading started at NSE in June At the outset, there was only one contract: Stock futures, stock options and index options were all prohibited.
In June , index options trading commenced. Stock options trading started in July and stock futures trading started in November Thus, the full set of equity derivatives products were only available in November In July and August , Nifty futures trading amounted to 0.
This jumped to 0. Starting from November , the growth in the number of contracts traded at NSE has been remarkable. The figure shows this time-series, in log scale.
The superposed time trend implies an average compounded growth of 5. Few derivatives exchanges worldwide have obtained such a hectic pace of growth in the early years after launch. The first interesting distinction is that between futures and options.
The figure shows the share of options in the overall derivatives trading at NSE. Options trading had a bit of a head start in the early days, since index options trading started in June and stock options trading started in July Hence, in the early months, individual stock trading was synonymous with options trading. Individual stock futures trading only began in November Options trading is intellectually more complex than futures trading, so it is to be expected that market participants took more time to gain comfort, and build skills and systems to cope with options trading.
In addition, the disproportionate aversion to options trading was influenced by two features of the institutional framework. NSE's tariff structure disadvantaged options, and there was a feature in the securities transaction tax a turnover tax used in India which penalised options trading.
NSE modified its tariff structure in in order to address this. More importantly, the provisions of the securities transaction tax were modified on 1 June From late onwards, global financial market volatility went up dramatically, which might have increased interest in options trading where payoffs can be controlled as opposed to futures trading where profits or losses are potentially uncontrolled. The share of options in are understated to the extent that currency futures trading began, which bolstered futures turnover, but currency options trading was prohibited.
Hence, the true shift in favour of options trading by the market is bigger than that portrayed in the graph. The second interesting feature in the evolution of derivatives trading at NSE is the share of index derivatives in equity derivatives trading. In the early days, index underlyings had a head start because trading in index futures from June and index options from June started first. However, the magnitude of derivatives trading present at this time was very smal.
In June , only 0. When stock options trading commenced July and individual stock futures trading started November , they tapped into the pre-existing knowledge, interest, capability and order flow for badla, the mechanism for leveraged trading on individual stocks which had been banned with effect from July This order flow immediately switched to individual stock futures and options, and the share of index derivatives dropped sharply, all the way to In early , the market had a new technique options and futures for expressing old ideas views on individual stocks.
The idea of trading an index was something new. The third dimension in which we can obtain insights into derivatives trading at NSE is the shift away from equity derivatives.
Currency derivatives trading commenced at NSE in August with a limited form of currency futures trading. At the time, trading was permitted in only futures on the rupee-dollar rate, options and swaps were banned, participations by FIIs and NRIs was banned. In other words, roughly one-tenth of the business of the typical NSE member firm is now currency futures trading.