Bombay Stock Exchange's appeal to SEBI for permission to create a market-making mechanism for delivery-based settlement of Futures & Options contracts on the exchange has not met with any success, it is reliably learnt.

BSE had launched physical settlement of single stock F&O derivatives in February 2011 for contracts expiring on and after April 13. Since F&O volumes are as good as negligible on the Exchange, it wanted to empanel market makers to create some interest in such contracts.

“We needed liquidity providers who must of course be compensated or provided some benefit. But that is not happening now as SEBI has not allowed us. Unless there is a market making mechanism such trading will not take off,” said a source closely associated with the Exchange.

Physical settlement

In delivery-based (or physical) settlement, contracts have to be settled with the underlying stocks instead of with cash. This kind of settlement is believed to curb speculative activity and bring depth to the market, as well as lead to a more meaningful correlation between the cash and derivatives markets.

SEBI allowed stock exchanges the option of offering physical settlement of F&O contracts last year. BSE opted for it whereas the NSE, which has a monopoly in the F&O segment, has not.

Now, with less than two weeks to go for the first expiry date for physical settlement, there is still no activity in F&O contracts on BSE, said brokers.

“There is zero participation. Everyone could use physical settlement, brokers and institutional investors. It is in the proper interest of long-term traders. It needs some marketing,” said Mr Deven Choksey, Managing Director, K R Choksey Shares & Securities.

He says it is a chicken and egg situation at BSE. The exchange was hoping to revive its F&O volumes through the exclusivity of physical settlement on its platform. Whereas traders say such transactions will take off only if there are volumes in the first place.

Who's interested

There are two kinds of entities that will be interested in physical settlement, said Ms Deena A. Mehta, Managing Director of Asit C. Mehta Investment Intermediates Ltd, a long time advocate of delivery-based settlement: “The first is the big trader who wants to sell a large quantity of shares. He would want a liquid market and huge volumes which are not available in the cash segment. But in F&O, there are no volumes on BSE, whereas all the volumes are on NSE where there is no physical settlement. So that purpose is defeated.”

“The second is the retail category where people want to take or make delivery of shares. But that looks unlikely because the stock lending and borrowing (SLB) mechanism has not taken off,” she said. (SLB allows those who have gone short to borrow shares and physically sell them for settlement of contracts. This system has been introduced on the exchanges but nobody has quite taken to it).

According to Ms Mehta, there needs to be a lot of promotional activity before physical settlement of futures contracts can take off. “Brokers themselves have to learn and then in turn teach investors,” she said. If SEBI has not allowed market makers then it is going to be very difficult for BSE, she said.

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