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Derivatives are financial instruments that derive their value from an underlying asset, such as a stock, an index, a commodity, or a currency. Derivatives trading allows investors to hedge against unfavourable price changes in the underlying asset, with speculation on future price movements. Derivatives can be traded on an exchange or over the counter (OTC).
The Bombay Stock Exchange (BSE) is the oldest and one of the largest stock exchanges in India. It offers a variety of products and services to capital market participants, including equity, debt, mutual funds, currency, and derivatives. The BSE Sensex is the flagship index of the BSE, comprising 30 large and well-established companies across various sectors. The BSE Sensex is widely regarded as the barometer of the Indian economy and the benchmark for the Indian stock market.
The Index Futures and Options (FnO) segment of the Bombay Stock Exchange (BSE) comprises derivative contracts linked to the BSE Sensex, BSE Sensex50, or BSE Bankex as their underlying assets. The Sensex Derivatives allows investors to trade on the movements of the Sensex without actually buying or selling the stocks that constitute the index. The BSE Futures and Options (FnO) were first introduced in the year 2000, but they did not gain much popularity and liquidity due to various reasons, such as high lot size, lack of awareness, and competition from other exchanges.
However, in a bid to revive and boost the derivative trading at the BSE, the exchange has recently relaunched its Derivative contracts with several changes and improvements. Some of the key features of the new BSE’s Sensex FnO are:
Reduced lot size:
The lot size of the BSE Sensex F&O and BSE Bankex F&O has been reduced from 15 to 10 and 20 to 15 for Futures and options contracts respectively. This means that investors can trade with a lower amount of capital and have more flexibility in choosing their positions. For example, if the BSE Sensex is trading at 75,000, the contract value of one lot of BSE Sensex futures will be 7,50,000, instead of 11,25,000 earlier. Similarly, the contract value of one lot of BSE Bankex Futures will be 11,25,000, instead of 15,00,000 earlier.
New expiry cycle:
The expiry cycle of the BSE Sensex FnO has been changed from Thursday to Friday. This means that the contracts will expire on every Friday of the week, instead of Thursday.
Increased awareness and participation:
The BSE has taken various initiatives to increase the awareness and participation of investors in the BSE Futures and Options (F&O). These include conducting webinars, seminars, workshops, and training programs for the investors, brokers, and intermediaries; launching campaigns and advertisements in the media and social platforms; and offering incentives for the active traders and market makers.
Benefits of Trading in BSE Sensex FnO
Trading in BSE’s Sensex Futures and Options (FnO) offers several benefits to the investors, such as:
Leverage:
BSE’s Sensex Futures and Options (FnO) allows investors to trade with a small amount of margin and control a large exposure to the BSE Sensex. This can amplify the returns or losses of the investors, depending on the direction of the market. For example, if an investor buys one lot of BSE Sensex futures at 75,000, he or she only needs to pay a margin of around 10% of the contract value, which is 75,000. However, if the BSE Sensex rises to 76,000, the investor can make a profit of 10,000, which is a 13.33% return on the margin. Conversely, if the BSE Sensex falls to 74,000, the investor can incur a loss of 10,000, which is a 13.33% loss on the margin.
Hedging:
BSE’s Sensex Futures and Options (FnO) allows investors to protect their portfolios from adverse market movements by taking an opposite position in the derivatives market. For example, if an investor owns some BSE Sensex stocks and is worried about a possible market crash, he or she can buy a BSE Sensex put option, which gives the right to sell the BSE Sensex at a predetermined price and date in the future. This way, if the BSE Sensex falls below the strike price of the option, the investor can exercise the option and sell the BSE Sensex at the strike price, offsetting the losses from the stocks. However, if the BSE Sensex rises above the strike price of the option, the investor can let the option expire worthless and enjoy the gains from the stocks.
Speculation:
BSE’s Sensex Futures and Options (FnO) allow investors to bet on the future direction of the BSE’s Sensex and profit from its fluctuations. For example, if an investor expects the Sensex to rise in the near future, he or she can buy a Sensex call option, which gives the right to buy the Sensex at a predetermined price and date in the future. This way, if the Sensex rises above the strike price of the option, the investor can exercise the option and buy the Sensex at the strike price, making a profit from the difference between the market price and the strike price. However, if the BSE Sensex falls below the strike price of the option, the investor can let the option expire worthless and lose the premium paid for the option.
Risks and Challenges of Trading in BSE Sensex FnO
Trading in BSE’s Sensex Futures and Options (FnO) involves several risks and challenges for the investors, such as:
Leverage:
BSE’s Sensex FnO can magnify the losses of the investors, as well as the returns, depending on the direction of the market. For example, if an investor sells one lot of BSE’s Sensex futures at 75,000, he or she only needs to pay a margin of around 10% of the contract value, which is 75,000. However, if the BSE Sensex rises to 76,000, the investor can incur a loss of 10,000, which is a 13.33% loss on the margin. Conversely, if the BSE Sensex falls to 74,000, the investor can make a profit of 10,000, which is a 13.33% return on the margin.
Volatility:
BSE’s Sensex FnO are subject to high volatility, as they reflect the uncertainty and risk associated with the price movements of the BSE Sensex. The volatility of the BSE Sensex can be influenced by various factors, such as economic, political, social, and environmental events, both domestic and global. The volatility of the BSE Sensex can affect the price and liquidity of the BSE Sensex FnO, making them more unpredictable and risky.
Complexity:
BSE’s Sensex Futures and Options (FnO) are complex and sophisticated financial instruments that require a lot of knowledge, skill, and discipline to trade successfully. The investors need to understand the market dynamics, the factors that affect the price of the BSE Sensex and the BSE Sensex FnO contracts, the strategies and indicators to analyse the market trends and signals, and the trading plan and risk management strategy to execute the trades. The investors also need to be aware of the rules and regulations of the BSE and the derivatives market, such as the margin requirements, the settlement procedures, the taxation implications, and the legal obligations.
Conclusion
The relaunch of BSE’s Futures and Options (FnO) is a new era for Indian derivatives trading, as it offers a diverse and attractive range of investment and risk management tools to the market participants. The BSE’s Futures and Options (FnO) can provide several benefits to investors, such as leverage, hedging, and speculation, but they also involve several risks and challenges, such as leverage, volatility, and complexity. Therefore, before trading in BSE Futures and Options (FnO), the investors should do their own research, understand the market dynamics, and devise a suitable trading plan and risk management strategy. They should also consult a professional financial advisor if they have any doubts or queries.
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