Derivatives assgn ppt

8/7/2019 Derivatives assgn ppt

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TRADING & SETTLEMENT

WITH THE

PHYSICAL DELIVERYOF SECURITIES

By

Group No: 5

Rakesh Dodai

Mayuresh Paralikar

Madhumita Saha

F-06

F-14

F-22


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Road Map

Name Roll No

Madhumita Saha

Rakesh Dodai

Mayuresh Paralikar

F22

F06

F14


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What is trading

Trading securities is the act of buying and selling securities

with the intention of making a quick profit. Brokerage firms

and investment advisers recommend buying securities for the

anticipated long-term appreciation of the company.


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What is Settlement

Settlement (of securities) is a business process whereby

securities or interests in securities are delivered, usually

against (in simultaneous exchange for) payment of money, to

fulfill contractual obligations, such as those arising under

securities trades.


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Physical delivery

Physical delivery in derivatives markets refers to settlement by

receiving or sending the underlying assets - stock certificates,

head of cattle - to the holder at the contract's maturation date

rather than send the cash equivalent (cash settlement).

Currently it takes place in NASDAQ and Dow Jones.

Indian regulators had attempted to go a step further in 2002

to dissuade some of the speculation in its derivatives market

of the Bombay Stock Exchange (BSE) and require that all

single-stock futures contracts be physically delivered.

Nonetheless, stock futures and options contracts continue to

trade on the BSE on a cash-settled basis.


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PHYSICAL DELIVERY OFSECURITIES


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MAKES SENSE IN CASE OF

OPTIONS ON STOCKS In India, options contracts on individual securities are

American style and are cash settled. Similarly, futures

contracts on shares are also cash settled.

Leverage benefits in futures market encourage large volume.

Better price discovery in the spot market.

Equate options and futures markets and ignored the

fundamental difference in these two instruments.

Exchange-traded equity options

The present practice in India of cash-settling option contracts

is fraught with danger and has on many occasions led to large

speculative practices.

Higher margin will take care of speculative practices in the

futures market.


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Physical delivery contd

SEBI appointed derivatives committee has suggested to

introduce physical delivery of securities.

This will limit the possibility of manipulation and also curb

excessive speculation. In the absence of physical delivery, the system simply flushes

out all trades at the end of the month when the contract

expires.(There is no logical conclusion to the futures trade).

Assets limited , cash unlimited

Fact - Futures contracts on many commodities have been

moved to a cash settlement basis instead of physical

settlement.


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The volume would fall sharply if physical settlement is

introduced.

The costs would go up if traders are forced to settle the

contracts in shares as traders will have to borrow shares. In the US, where physical settlement is followed, the volumes

have hardly picked up.

It is believed that the issue was discussed in the secondary

market advisory committee (SMAC) meeting held recently.

Brokers are unclear as to how securities transaction tax (STT)

will be charged on the transactions settled in the physical

form.


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In the physical settlement, the seller will have to deliver the

underlying shares at the time of expiry of F&O contracts, if he

has not squared off his positions till then.

The buyer will have to take delivery of shares, if his position isopen on the day of expiry.

Brokers fear that investors and traders may end up paying STT

more than once for a single transaction.

For derivatives transactions, STT is levied at rates applicable to

non-delivery deals on the day of trade. Investors or traders

may have to pay STT once more when they actually deliver

securities in the physical form at the time of settlement, at

the rates applicable for delivery-based transactions.


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If they borrow or buy securities for the purpose of delivering

in the market, such transactions will also attract STT.

Issue multiple taxation

STT forms a large part of the overall cost of delivery-basedtransactions.

Currently, STT is charged at 0.125% of the turnover for

delivery-based cash market transactions, on both buy and

sell sides. It is charged at 0.025% on the sell side of non-

delivery-based transactions. The rate is fixed at 0.017% for

sale transactions in the F&O segment.


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Sebi gave stock exchanges four choices

o cash settlement for both stock options and stock futures,

o physical settlement for both stock options and stock futures,

o cash settlement for stock options and

o physical settlement for stock futures or the other way round.

The new process is expected to reduce instances of

manipulation in derivatives contracts, particularly of the

companies with low floating stock.

The derivatives market is more liquid than the cash market.

Investors wanting to buy or sell large quantities and give or

take delivery of the shares can take advantage of physical

settlements.


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Physical settlement of derivative trades good for price

stability

Volatility will increase in the last week prior to expiry. The

market will see more roll-over and more close-out of existingpositions because of two reasons:-

o One, the retail investor's mindset would take some more time to

accept physical delivery of the underlying as a fact of life.

o And two, very few people have the financial wherewithal to take

delivery. Physical delivery of the underlying would largely finish off

the value weighted average price (VWAP) for arbitrage

settlements.


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Market volatility that normally increases around the

settlement date nowadays would get tempered once physical

delivery ushers in.

The prerequisite for successful implementation of physicaldelivery is the presence of a robust securities lending and

borrowing mechanism (SLBM) simply because it would enable

entities with short positions to deliver the underlying, in case

they do not possess them.

The main reason for the delay: NSE, where about 99 per cent

of all equity derivatives trading volume happens, has given a

lukewarm response to the proposal.


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For investors doing strategy-based simultaneous trades in

cash market and stock F&O, a delivery-based settlement helps

them as they do not have to square off their cash market

trades on expiry.

A system which dispenses with physical delivery is an unsound

economic system because it severs the markets only link with

the real economy.

The danger of excessive speculation, particularly short selling,

is heightened by the cash settlement system because it is

easier for speculators to arrange cash than to arrange shares

for settling a position.


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Hence, delivery requirement automatically acts as an

instrument of market discipline. It keeps the tendency

towards excessive speculation under check.

Physical settlement of stock futures will have two moreimportant advantages. These are :

o It will facilitate arbitrage between the futures market and the cash

market, thereby ensuring that the prices remain properly aligned.

o It will help to attract genuine long-term investors into the futures

market by enabling them to acquire securities either from the futuresmarket or from the cash market, as they may find advantageous.


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There are several benefits which will flow from this. They are:

o It will further help in price alignment, make the futures market

investment-oriented to some extent rather than remaining purely

speculative and will increase liquidity in the distant month contracts

which presently have no liquidity.

Cash settlement of futures in deliverable assets has nothing in

its favour except the lobbying power of the speculators.

When derivatives contract are settled physically, there will be

implications for all players in the derivatives segment speculators, arbitrageurs and hedgers.

The speculators today have all profit and losses settled in

cash.


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RISK MANAGEMENT


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Risk Management

Margining System Parameter to be considered

Historical price volatilities

Current and anticipated market conditions PRiME (Portfolio RiskMargining System of HKEx)

Assessment of the maximum potential risk exposure of aportfolio over a one-day period under different realisticallysimulated market scenarios

Movement in the prices Volatilities of underlying assets

Time until expiration

Risk-free interest rate


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Risk Management

DailyMark-To-Market

All open positions are revaluated daily

on the basis of their respective closing prices, losses should

be settled before opening of next trading day

AdditionalMargin on Concentrated Positions

HKCC can impose additional margins on individual

Participants

If a Participant holds positions that account for more than30% of the market risk and the total net open interest

exceeds a certain number of contracts e.g. 20,000 contracts

for HSI Futures, HKCC will increase the margin level by

20% on that Participant.


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Risk Management

HolidayMargin Arrangement

Mitigate the potential market risk on the reopening after the

holiday break

One day Holiday Mandatory to adjust the intra-day call before holiday

More than one Holiday

Mandatory intra-day adjustment

Raises margin level for some major products

Monitoring Client Exposure

HKFE sets a position reporting level for eachMarket

Not allowed to hold positions in excess of 10,000 delta


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Risk Management

HKCC Participant'sDefault

HKCC managed Reserve Fund

Customer positions are netted against each other

HKCC Participant's margin money is applied to anydeficits after netting

Further deficit is withdrawn from the Reserve Fund in

layers

Under no circumstances will customer segregated margindeposits held by the Clearing House for one HKCC

Participant be used to cover either a house or customer

default of another HKCC Participant


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Risk Management

Reserve Fund

To meet its obligations as the counterparty in case of

participant defaults

Reserve Fund Participant contribution

Interest on deposits

Size of the Reserve Fund is monitored by stress testing

Market movement assumptions Default assumptions

30% of the loss-making positions default

Participant with the largest projected loss defaults

Collateral provided by the clearing participants

Derivatives assgn ppt

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