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Impact Analysis of Mutual funds participation in Derivative segment Research Team | Posted On Wednesday, April 08,2009, 04:29 PM

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Impact Analysis of Mutual funds participation in Derivative segment



There are some of the following possible impacts of Mutual funds participants will be on Derivatives and Cash segment.

1. Introduction of structured product regime.

As on nowadays the mutual funds had been offering the plain vanilla equity and debt products with add-ons. The new guidelines are likely to facilitate the way for new administration of structured products where the mutual funds will be able to offer hybrid of equity, debt and derivatives products with varied features in terms of risk – reward parameters.

Some of new product structures could be :

  • Limited Loss Products
  • Hedged products
  • Index based products
  • Fixed Income products

2. Greater opportunity for the Retail Investors to avail advantage in Derivatives

The retail investors will have even more options to decide between various options. It is predictable to benefit the retail investors of Derivatives in the same way as the retail investor of equity. The investors will get a possibility to diversify their derivatives portfolio with much lesser investment than otherwise in the form of periphery money require in direct derivatives segment. Furthermore portfolio will be in the hands of professionals, which will reduce the unsystematic risks.

On the other hand the accessibility of leveraged products at leaser investment would attract and develop new investing community, which are as on these days are not investing in Mutual funds due to not as much of risk reward philosophy. In Debt segment also Mutual funds can have cannibalization gain in which mixture of debt segment and derivatives can keep returns far more favorable and competitive in comparision to other investment avenues.

3. Greater liquidity and market depth

Mutual funds are now qualified to take positions in directional bets and not just hedging. By considering a variety of position limits as specified by SEBI, it is likely to add liquidity of Rs. 75000Crore per month which will fuel Derivatives segment activity and Dependence of FII on Derivatives segment can be decrease by greater extend. At present derivatives segment seems to be underutilized and the open positions are skewed towards the near month contracts. As a effect the derivatives segment is yet to reap benefits of numerous strategies particularly the time spread strategies.

The combination of liquidity will encourage trading in lower maturities in both futures and options with relatively lesser impact cost. This will not only get better the market structure but will also open room for applications of more difficult strategies, which generally fall within the purview of institutional trade.

4. Improved Pricing Efficiency

As we know that higher the liquidity and greater will be number of institutional players will improve the pricing efficiency as this will direct to enhanced market making which is currently not present in middle and far month contracts. After the authorization to Mutual funds to trade in Derivatives segment options segment will be major beneficiary as market making institution will lessen the bid ask spreads in all the maturations. This will be a advantage for retail investors who will get more opportunity for investment in options.

5. Decline in arbitrage opportunities

Efficient market making will show the way to greater pricing efficiency. This will contract the spread between the spot and the derivatives segment, which will practically eliminate the arbitrage opportunities between the two.

For this reason this may prove hard for the arbitrageurs and the arbitrage mutual funds. Nevertheless liquidity in options across the entire horizontal (price) and vertical (time) spectrum may give grow to synthetic and cross arbitrage opportunities.

6. Undue market volatility towards settlement

With directional investments coming in from mutual funds after this authorization, the derivatives settlement cycles are likely to be exceptionally volatile and jerky. Unwindining of large open positions towards the termination will induce additional volatility in the markets. The stocks where the liquidity is currently limited will also come in the domain of higher activity and trading interests due to large liquidity flowing into their derivatives instruments.

This will pay a way to good trading opportunities in relatively smaller stocks too. Higher volatility is further expected to improve the pricing in the options section.

Thus it is to be wind up that by permitting Mutual funds to trade in Derivatives segment will not only benefit retail investors to hedge their positions without directly burning their fingers in highly volatile and risky Derivatives segment but other players like HNI and FII will also benefit due to much needed liquidity in Derivatives segment. In conclusion only time will tell the success and failures of Mutual funds trading in derivatives market till that period of time everyone will enthusiastically watch the whole drama which is about to unveil for a bright future of Derivatives from Mutual funds side.

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