Futures contracts not being used as hedging tools

Futures contracts not being used as hedging tools
15 Feb, 2008, 0123 hrs IST,Shakti Shankar Patra, TNN

Futures contracts were meant to be tools for risk management, but they have ended up being just an alternative to the infamous badla system. Futures were basically designed as hedging tools and participation in them, the world over, increases exponentially during times of extreme market volatility.

However, in India, things don’t quite follow global convention. Data reveals that only the Nifty futures contract is used as a hedging tool. Stock futures, on the other hand, are being used purely for speculative purposes. A detailed comparison of participation in both the Nifty as well as stock futures during the May-June 2006 crash with the recent market crash witnessed in mid-January, provides clear evidence in this regard.

In 2006, the Nifty topped out on May 11 and found its bottom about a month later on June 14. During that period, while the open interest in the Nifty futures went up by more than 4%, stock futures had cumulatively shed a humongous 54.13% of their open interest. Between January 8 when the Nifty made its top and February 13 when the build-up in the Nifty futures remained steady, stock futures shed a strikingly similar 53.36% of their open interest. Ideally, any volatile period such as this one should have seen an increase in futures participation rather than a complete meltdown.

That stock futures have just ended up becoming mere speculative devices becomes even more blatantly obvious when we compare the turnover of the punting favourites in the stock futures with their corresponding cash turnover before and after the crash. For example, on January 8, MRPL, which caught traders’ imaginations with double-digit intra-day jumps on more than one occasion had a cash turnover of just Rs 44.34 crore compared with a turnover of Rs 128.74 crore in the futures segment, almost three times. However, by February 13, the futures turnover had fallen below the spot market volume. The same has been the case with most other liquid F&O scrips.

However, some stocks like RNRL and Neyveli Lignite, which were among the most-severely battered during the panic on that fateful Tuesday, still continue to be favourites amongst futures speculators. It seems evident then that those bitten by the futures speculation bug, refuse to see the writing on the wall. Even the regulator’s attempts to curb excessive speculation by setting market-wide limit for individual scrips has ended up becoming more of a tool in the hand of speculators rather than being a hindrance.