Tuesday, December 7, 2010

Hike in Investors application amount in retail category : A Boon or Bane ?

SEBI has reserved 35 % of the IPO for Retail Investors. An Investor intending to apply under the category of Retail Investors can apply for not more than Rs 1 lakh. but Since November, 2010 SEBI has increased the limit to Rs 2 lakhs. Now Investors can apply in IPO under Retail category for up to Rs 2 lakhs.

The biggest appeals in applying under retail category are
a) Investors may get discount of 5% on IPO price in case of PSU IPO.
b) With recent SEBI guideline, IPO is open for one extra day for only retail Investors to apply. Hence Retail Investors can apply after looking at the appetite on HNI and Institutional Investors.
c) There is probability of getting higher allotment.

SEBI has increased these limits after 5 years, to cater to demand of investors for higher participation in IPO. 

The advantages perceived by SEBI with increase in Retail limit are

a) Higher amount of participation by Retail Investor.
b) Higher Allotment in retail category.
c) Wider appeal to Investors.
d) Option to Apply after closing of bids for HNI and Institutions.

But does it mean that doubling the limit will lead to doubling of absolute returns ?

Below is the application status of recent IPO with Retail  application limit of Rs 2,00,000/-. Along with is the  probability of allotment, in case the application amount would have been Rs 1,00,000/- only

Name of Co

Issue size (Retail)

Retail Limit


Prob of Shares allotted

Cost of Fund @8% for 15 days

Retail Limit


Prob of Shares allotted

Cost of Fund @8% for 15 days




32.86 times




18 times





6.56 times



4 times



In above table, We find that increase in Retails limit leads to no increase in allotment or there is marginal increase, wherein there is also rise in interest cost whereas Opportunity cost is not considered.

I would request you to read below mentioned points for the answer

a) Who will take advantage of this limit hike ?

I think the Investors who were investing for Rs 1,00,000/- will only hike their limit to 2,00,000/-. We will get the rationale of this view by looking at the subscription pattern in retail segment. Most of the applications are at upper limit leading us to infer that most of such investors have surplus and they invest up to maximum limit and thus when the limit is hiked many of them would apply for higher amount.

I also don't think that Investors applying for Rs 2,00,000/- in HNI category will apply in Retail category (Because looking at past data , the returns by applying for Rs 1,00,000/- was more than applying in HNI for Rs 2,00,000/-.)

There is a grey market for application where the investor applying in retail category get lump sum amount irrespective of returns for IPO. The prevalence of such market indicates that there is appetite for higher amount of retail category. so if the limit is hike people would put in higher amount.

b) After inferring that people who were applying in IPO in retail category for Rs 1,00,000/- will in all probability apply for Rs 2,00,000/-.

But would that mean that allotment will be double with increase in limit. but I really feel that allotment would be somewhat more than half of what was allotted previously. To understand this rationale we will look at some examples

i) In past 6 months most of the IPO are over - subscribed by more than 1 time in retail category except in few cases where it was under subscribed because of lower quality of issue and not because the size was big and limits of Investors were exhausted.

ii) The MOIL issue was oversubscribed 32.86 times in retail category. The Investment limit in retail was Rs 2,00,000
iii) The SCI issue was oversubscribed 6.56 times in retail category. The Investment limit in retail was Rs 2,00,000
iv) The Claris Life Science issue was oversubscribed 1.60 times in retail category. The Investment limit in retail was Rs 2,00,000. This issue was not subscribed because of Higher IPO price, in fact they have reduced the IPO price.

In the above scenario if the Limit would have been 1,00,000 /- I guess the subscription times would be almost 50 % (Eg 18 times for MOIL, SCI at 4 times). but the number of shares allotted would have been same.

In fact we are blocking twice the amount and receiving the same quantity of shares thereby reducing our returns in percentage terms by 50%.

d) We should also consider the opportunity cost of extra 1,00,000/-. Funds are scarce resource, if that amount is invested in another issue,maybe the returns would be higher.

Does that mean Such Limits should not have been relaxed ?

No, The limits should have been relaxed in Slabs. If the Issue size is large enough to handle bigger amount, than only 2,00,000 / - limits should be applicable. For Example issue for more than Rs 2000 Cr or 3000 Cr in Retail category. Such Slabs will ensure higher retail participation for bigger issues and smaller issues will ensure lesser blockage of funds. Also leading to lesser logistical hurdles.

I welcome your critical comments and suggestions.

Saturday, October 30, 2010

Introduction of European Options in Stocks. (What will change)

SEBI came out with a circular on 27th November, 2010 giving freedom to Stock Exchanges for choosing style of Options (European / American) on Stocks. It gives flexibility to stock Exchange to offer either European style option or American Style Options.

Options were introduced in 2001 in Indian markets and SEBI had made it mandatory that all Index Options have to be European Style options and all Stock Options should be American style option.

Now SEBI has given liberty to Stock Exchanges to decide on the types of Options, they intend introducing on Equities.

A day after, SEBI issued these circular, NSE on 28th November, 2010 came out with a circular stating that NSE has decided to introduce European Options on Stocks instead of American Options on Stocks. The implementation date of such change is from January, 2011 contracts which were to be introduced for trading the following day 29th November, 2010.

There are different issues to be discussed on this move :
a) What will change ?
b) Why was there a sudden and abrupt change ? 
c) How would it impact trading  and Volume ? How would there be change in value of Options?

A) What will change ?

American Options provided right to holder of Options to exercise the options on any trading day during the life of option, whereas in case of European options, the holder can exercise his right only on last day of options (Expiration day).

With Exchange introducing European stock options for Jan,2011 series, Investor will have to understand that they can not exercise their options before the expiration date, nor would there be assignment of any options.

It means they can only sell or buy such options to liquidate their positions, but there will be price (premium / discount) for deep in the money calls and puts. It simply means there will be higher cost on liquidating of positions.

Optimal Exercise of  Calls are before the Ex dividend date and Puts are optimal to exercise as they become deep in the money, but with introduction of European options , things would become simpler but will would also mean that the prices would not deal with all dynamics of market pricing (like Dividends, Open offers, Buy Back).

So when you want to trade in stock options from January, 2011 contracts, you will have to search


You will have to search using CE (call European) and PE(Put European), instead of CA (Call American/ Put American)
We will discuss change in valuation of option in part C.

b) Why was there a sudden and abrupt change ?

NSE took a prompt decision to implement to introduce European Options in one day. SEBI circulars says that such decision was taken after taking views from Stock Exchanges.

SEBI must have given this flexibility to stock Exchanges as they may have felt that Risk management mechanism of Stock Exchanges are robust and it is perfectly operational. I don't think SEBI has taken views about it from all categories of market participants and I guess most of them must be unaware of such development.

There is also no clarification on the reason for change ?  Was it demanded by some section of participants ? or was some empirical studies done before such move ? Was it a proposal from Stock Exchange ?

Overall Risk Management committee of SEBI insisted on American Options on Equities, when it was introduced  in 2001 ? It was suggested by SEBI and leading academicians of the country in this field.

What is the rationale of such order by SEBI now ?

Further SEBI would have expected  from Stock Exchanges to get feedback and discussion for its participants. but how would NSE have taken a view from market participant when they just implemented it in a day.

Why was there a rush to implement such move ? Was there any compulsion from section of market participants ? Have NSE done any empirical studies for such move ?

SEBI guidelines say that, Once Exchange decides the change in Style of  stock options, they have to take permission from SEBI regarding the same and also they have to inform the general public about the change, at least before one month of implementation. Has NSE failed in following SEBI guidelines. Maybe they would have got the SEBI approval in a day but One month notice to all stake holders and Public. I guess they have missed (January, 2011 contract was introduced from 29th November, 2010.)

In fact Exchange should have put up a proposal for change in style of options and invited public opinion, before its implementation.

My view about  this NSE move is that it is only to accommodate certain section of participants and to garner higher volumes. They are not interested in the price discovery process.

I perceive FII's are very active in Index Options but they are not very active in Stock Options. The probable reasons could be higher volatility in stock futures, lower liquidity in stock futures, lower market wide open limits in stocks. But I am sure FII's deal with such situations in all geographies.

There are more than 224 stocks on which Options are allowed in India. If you are a fund manager sitting in different geographies and managing funds in many geographies, it would be tough to track optimal exercise / assignment probabilities on all stocks (If the Options are American).

Though Stock Options in developed Geographies like America and Europe are American options, Such players may have suggested that it is difficult to track all stock options for optimal exercise and probability of assignment and hence FII's may not be trading in Stock Options in India.

In order to woo FII's and help them get away with complex calculation of valuing and monitor American stock option, NSE must have implemented European stock options. 

SEBI guidelines Indian Institutions as of now are not allowed to write options, they can only buy options. Will such a move give FII's an edge.

Also I am not sure, how would market wide position limit impact such options. Because if holder of option cannot exercise his rights and he cannot find a buyer (Not because nobody wants to buy, but they cant because of market with open limit). Worse if somebody is short and wants to cover, when it is in ban period?

 It may increase the volume on NSE  and income in long run, but I guess we will miss on price discovery process as European options can be easily calculated using Black -Scholes model ,( where the reality of dividend, open offers and buy back does not exist)

We will be trading on raw product where many market dynamics are absent, I guess NSE should have introduced Options on Stock Futures (Futures options) instead of Stock Options.

I hope NSE has done its homework and does not have to take a step backwards, as in the case of introduction of Derivatives instruments on GoldBees, where they have to cancel such introduction after making the announcements (incidentally NSE did not bother to take participants view on that move also).

c) How would it impact trading  and Volume ? How would there be change in value of Options?

With introduction of European options, Exchange must be expecting the rise in options volumes. They may be banking on the participation of FII in market making in Stock Options also. I expect that this move may create higher volumes as these are simpler products compared to American Options.

But different strategies prevailing in markets will vanish or will become unviable.

We will now try to discuss some changes in valuations and Strategy.

The Basic difference between American and European Options is timing of Exercise. American Options can be Exercised any time during the life of options, but European options can be exercised only on Expiration day.

European options are comparatively easier to value using Black Scholes models, where the models takes in to consideration the final price and not the path it moves before such price. Its basic assumption is there are no dividends on the stocks. But that's a myth in real world. 

We will see the changes in upper boundary and lower boundary of options.
Boundaries are the maximum and the minimum price of an option.

American Option
European Option
Call lower  boundary
Spot price – Strike price

Spot Price – Strike Price + Cost of carry
Futures Price  – Strike Price + Cost of carry(Options Price only)

Call upper boundary
Price of Stock
Price of Futures (No Matter if Stock Price is Higher or Lower)
Put  lower Boundary
Strike price – Spot price
Spot price – Strike Price – Cost of Carry
Strike Price – Futures Price – Cost of Carry
Put  upper Boundary
Strike Price
Strike Price – Cost of Carry

From the above table ( I have tried to be as simple and not bring in formulas or signs), we can see that there will be higher impact of cost of carry on option prices. In simple words Calls will become costlier and Puts will become cheaper. Put may be available below their intrinsic value but it has to be carried and cannot be exercised. Calls will remain costly and you wont be able to exercise, if it becomes deep in the money (No doubt you can sell it , but there will be problem of liquidity in such strikes).

In India,  Stock futures are not entitled for dividends (unless it is more than 10% of stock price) and hence they are quoted at a discount to spot price to the tune of dividend and on Ex dividend date the stock price falls by the amount of dividend and again the difference between spot price and futures price is cost of carry.

Next would be impact of dividend on options. As of now all in the money calls were exercised (where Put price was less than dividend) on the eve of stock going  Ex - dividend. That was the reason of higher option price. European options cannot be exercised before expiration date and stock may go Ex dividend during the life of option which may reduce the price of call as dividends cannot be optimised on European options.

Also there will be optimal exercise in cases of buybacks and open offers. Calls can be exercised on last  day of trading where the stock can be bought in cash market and buyers can participate in such offers.
Also I perceive that calls price and put prices will fall, ( Technically Implied volatility will reduce)  because theoretically Europeans options are cheaper than American options.

To summarise price of options may fall (Lower IV), but Options needs to be carried till expiry (you can sell it).

When you look at price of option, don't look at Spot price of stock, but look at its futures price and value it accordingly.

I welcome your suggestions and critical comments.

Tuesday, October 12, 2010

Introduction of Pre Opening Session on NSE

Further to my blog on Pre-opening session and SEBI guidelines,

NSE came out with guidelines on Pre opening session.
There will be Pre - Opening session on National Stock Exchange of India Limited (NSE) from 18th Oct, 2010 for determination of credible opening price.

The Key takeaways and Precautions of this circulars are as follows :

a) Pre Opening session is meant to discover opening prices thereby reducing volatility in price at the open of the market. Initially only only Nifty and Sensex stocks are included in Pre opening session, but eventually Pre opening session will be there for all stocks, when the systems is stabilised and running without hindrance or improper price computation (Pre Opening session was there in India in 1999, but It was discontinued after instances of flaws in price computation algorithm)

The Pre Opening Session is there only in Cash Market and there will not be a pre opening session in Derivatives market. 

b) The Pre opening session will start at 9.00 am and will close between 9.07am  to 9.08 am randomly to avoid and foul play at last moment. The normal Cash market will start at 9.15 am after getting confirmation of trades in pre opening session. There is no clarity on change in timing of derivatives market, but I guess F & O market will also start from 9.15 am.

c) There will be a separate book for pre opening session in market. It will be called as PO, So if you wanna trade in Pre opening session you will have to trade in PO book (EQ : Normal Equity , BE : Trade to Trade Stock) and than during normal market trading will take place in EQ book.
All pending orders which are not matched in Pre opening session will be automatically transferred in normal market. The un executed market orders will be transferred as limit orders at opening price.

d)  Order Matching Logic. : The order matching logic in pre opening session is as follows, The priority will be given to limit orders, and than the market orders (It is reverse of what was there in earlier Pre opening session). First all limit orders will be taken or price computation and traded, if there is any unmatched quantity , market order will be considered on both sides and then market orders will be matched with market orders at equilibrium price  (Opening price)

My sincere suggestion, Try to put limit orders for better execution.

e) The opening price will be the equilibrium price at which the maximum quantity of trades can take place. If there are 2 equilibrium price in computation, than the price which is closer to closing price will be taken as opening price. 

In case of Only market orders, the previous day closing price will be takes as opening price and if there are no trades in pre opening session than first trade in normal market will be taken as opening price.

f) All un-executed orders will be transferred from pre opening book to Normal market, limit orders will be limit orders and pending market orders will be limit orders at opening price or previous days closing price, what ever the case may be. 

All pending order will have price / priority based on pre opening session time stamp.

g) The Risk management structure will be same as normal market.

It is a good move by SEBI, in reducing market micro structure impact in price discovery process.

But there are some unresolved issues , which I am sure will be resolved on later date, 

i) What will be the opening time for Derivative market segment ? 9.00 am or 9.15 am. ?

ii) There will be impact on price discovery process and there are higher volumes on Derivatives market and market will have to wait for opening session to be over and then only position on Derivative market can be cleared after seeing the opening price on Cash segment. But academically it is found that there  exist lead - Lag relationship between derivatives market and Cash segment and Derivatives market takes the lead and Cash Segment lags behind.

In such situation there lies a probability that there will be a opening price in Cash segment, but Derivatives market may show a different price (In terms of Percentage change from closing price after considering cost of carry for n days). In such case Cash price will immediately drift from opening price to price discovered in Derivatives market. (Only time will say about this behaviour) 

iii) Market orders are meant for prompt execution, whereas it carries a disadvantage in pre opening session, In fact we cannot term it as a way to get cut-off because you are not assured of a trade at opening price. 

It may be advisable for SEBI to disallow market orders in pre opening session as they have disallowed disclosed quantities.

I will update to BSE process of Pre Opening session , after BSE come out with the guidelines.

I welcome your critical comments and suggestion.

Saturday, September 25, 2010

Delisting of Satyam Computers from NYSE

Mahindra Satyam was down 25 % on 24 , Sep 2010 because Tech Mahindra will delist the stock from NYSE from 14th October. The company has said that they are delisting the stock from NYSE as they may not be able to meet regulatory guidelines in declaring results with US regulator SEC.

From 15th October, Mahindra Satyam will be traded in US on OTC desk. 

The question is how would Satyam react on Monday on Indian Bourse. 

Please understand the facts before you decide.

a) ADR are traded on American stock Exchange and American investors can participate in the company. 

By buying ADR the investors are not required to follow SEBI and Indian government guidelines and law. Also they are not exposed to Exchange rate risk of currency.  Also it's easy for them to trade in that stocks.

Because of such reasons ADR are always quoted at a premium to price at which they are traded in their country (Satyam ADR and Satyam price on NSE). This is true for most of the ADR and the same was true for Satyam.

That's the reason we have seen few sponsored ADR like Infosys Tech.

b) ADR of Indian stocks are two way fungible, it means that ADR can be converted in Equity any time if Equity price is more than ADR conversion price. Also Equity shares can be converted into ADR if ADR is quoting at a premium to Equity price , subject to maximum of the issue size of ADR.

c) The price of Satyam ADR was 6.12 $ before the notice of delisting. At price of 6.12 $ , The rupee value (Conversion value at 45.50) of ADR was Rs 278.50. Each Satyam ADR is equal to 2 Shares of Satyam. So the value of Satyam should be 139.25. which is at 39 % premium to Equity price at Rs 100.25.

d) Satyam ADR closed at 4.67 $ recovering from 4.38 $. The rupee value of Satyam ADR would be (Conversion value at Rs 45.50) Rs 212.50. Each Satyam ADR is equal to 2 Shares of Satyam. So the traded value of Satyam is 106.25.

Does it mean that Satyam stock will open sharply lower on NSE on Monday , because the ADR was down by 25% ? I doubt about the free fall. 

The fact as I can infer is that Satyam ADR was quoting at a premium to spot price to the tune of approx 40%, but with delisting of ADR from Stock  Exchange, it has to lose its premium which it was commanding as a listed ADR, but now it would be traded on OTC desk making it illiquid stock and again that will compel investors to quote lesser ADR premium. The fact that Satyam ADR made a low of 4.38 $ at which the conversion value comes to 99.50 per share and than it bounced back. 

Also the fact is that the Satyam ADR volume was around 2.17 crores shares on NYSE, it seems huge quantity of shares have changed hands and there are contrarian bets.

I agree that with fall in ADR price, there will be pressure on Satyam stock but it should be looked sentimental fall and nothing has changed in company for us.

The Satyam ADR was commanding a premium on Satyam stock as it was listed in NYSE. With delisting of Satyam ADR from NYSE has shranked is on the premium on ADR and there is no fundamental change in value of company.

We can look forward to results of the company before taking a Investment decision.

Friday, September 17, 2010

Listing of Share in Trade to Trade Segment

There is a always a huge volatility on the first day of listing of stocks. Most of the times it has happened that trades have taken place at very high or low price before the price settles. This is true for shares listed because of mergers, De-mergers, suspension or any other corporate action in the company.

Stocks listed after Corporate actions are volatile and trade takes place at outlier price because

a) There is no price band on first day of listing.
b) Most of the Investors are not aware about the true valuations of the company.
c) Speculative elements enter to trade in such stocks as they will have action because of volatility.
d) You can square off you position booking profit or losses.
e) The companies are also not transparent about the valuation of the company

To curb excessive volatility of stock on day of listing SEBI came out with the proposal to list stocks in T2T segment of the exchange, the salient features of the circulars are

a) All stock listed / Re listed after corporate actions would be traded on T2T segment of the exchange.
b) All such stocks would be traded in T2T segment for 2 weeks (10 trading day), then they can be moved back to EQ segment.
c) There will be no circuit limit on first day of listing.
d) The scenarios in which shares would be traded in T2T segment are Merger, De merger, Capital reduction, capital consolidation, Scheme of arrangement, CDR packages etc. Also if the Shares are allowed to traded in permitted to trade category and if the shares are Re-listed after 1 year.
e) Such rule wont be applicable on stocks which are traded in derivative segment, of are part of Index which is traded on Exchange (Nifty, Bank Nifty, IT index and Bank Nifty)
f) There was a write up "that settlement of the trades will not be done by exchange", it was a mis - understanding, The truth is trades will be cleared by exchange but under he rules of T2T segment.

The biggest advantage of such move is that only serious players will come to trade in the stock, which will reduce volatility in stock and gradually lead to price discovery. The price manipulation cannot be done on first day as the speculator will have to give delivery and take delivery and it is perceived that investor will get right price.

But We have to look at this circular critically also , there are disadvantages and there are better ways to handle such situations.

a) We have seen that price of stock falls if it is shifted to T2T segment, because of such reason price discovery process will be flawed as most players will be ready to trade at discounted rate because of market micro structure.
b) There can be serious price manipulation as traders will not participate and the manipulator can rig or suppress the price as per his interests , thereby sending wrong signals to investors.
c) There is no clarity whether original stock would also be traded on T2T segment on EX date ?
d) I perceive that price discovery will be flawed as investor/ speculator would sell the stocks or wouldn't buy the stocks before the EX date as they may get struck with position in T2T segment, even institution wont prefer such positions.
e) There are better ways to deal with such situation, Companies gives details of Swap ratios and salient features. but most investors are not aware about the valuations. They are not aware about the true position of companies, their assets and liabilities. they may not even have balance sheets or they are vague. The Investors are not aware about assets and liabilities the companies have in case of Mergers, De-mergers, scheme of arrangements or re listing.

The companies are not mandated by listing guidelines of the exchange to give such in depth details, most of the time you would get is salient features and swap ratio.

SEBI can make it mandatory under listing guidelines about the valuations of the companies, its balance sheet at the time of listing and any other material information which can impact the price of the stock.

I am sure , if Investors have such data they are competent to price the stock and trade, and price discovery will be smooth.

f) SEBI can make mandatory listing of all stock in specified time in case of merger/ De-merger or scheme of arrangements to avoid change in position and developments of companies which can change valuations.
g) It is also found that no data is available to investors in case of Re-listing and permitted to trade, There is no data on balance sheet and other facts of the company (Sometimes we only know the name). SEBI can make it mandatory for Exchange to collect latest balance sheet, and other data including latest share holding before they are listed or allowed to trade.

I am sure such measure would be a better precursor to price discovery process rather than shifting the stock in T2T segment.

Thursday, September 2, 2010

SEBI clarification of signing Power of Attorney for Demat Accounts

Most of the brokers expect their retail clients to have demat with them and also provide Power of Attorney (POA) to brokers for Direct Pay - In and sometimes POA is also issued for Bank transfers. It is advisable and helpful for logistical purpose. 

The advantages of POA are 
a) Client need not worry about the pay in as Direct pay In can be done.
b) Client can have direct pay- out in account (Else Brokers will check Debits in accounts and then transfer the shares as most of the time clear Payments from client is received in T+2)
c) Brokers can give leverage to clients based on his portfolio.
d) Clients can always track their portfolio from statements

But such POA issued by clients were also mis - used by Brokers (In some cases) , they were
a) Brokers used to take blanket POA for Demat accounts and they are irrevocable.
b) Such POA were misused in case of some issues between client and Broker (When Clients used to make losses and Clients would say we are not aware of such trades )
c) Brokers used to withdraw shares abruptly from demat accounts under the pretext of Margins and margins shortfall.
d) Brokers used to transfer shares in pool accounts without pay in.
e) Brokers used to sell shares of clients to meet its pay In.

To overcome such flaws and misuse, SEBI came with revised circular pertaining to POA to be issued to brokers for Demat accounts. The features of the circulars are

a) It is not mandatory for clients to issue POA to brokers except in case of Internet Trading.
b)The POA should used to meet pay In and Margin requirements only.
c) The POA should be issued on Brokers firm name (SEBI Registration name) and not on name of any authorised person / employees of firm.
d) The POA can be issued for applying in IPO, Open offers, Right and Mutual funds
e) The POA should mention the account numbers and Name, where the shares / Funds can be transferred (Pool account for Demat and Client account for Funds)
f) The brokers have to maintain Audit trail for such transactions.
g) POA should not provide the authority to transfer the rights in favour of any assignees.
h) POA should contain a clause that any erroneous transfers from clients would be returned.
i) POA should be revocable any time.
j) POA should not facilitate off- market transfers 
k) POA should not give rights to open accounts with brokers or Depository.
l) POA cannot prohibit client from operating that account
m) POA cannot allow transfer of funds in family accounts to offset debits.
n) Duplicate/ Certified true copy of POA should be given to client.

To Download SEBI circulars 

Circular Circular I

Sunday, August 29, 2010

Mid Day Multi Media (Two shares at the price of one)

New developments 

Midday has sold its print business to Jagran Prakashan. The pay off is in form of Shares of Jagran prakashan. The Ratio of Shares to be issued is 2 shares of Jagran for every 7 Shares of Mid - Day. Along with that the share holder will own shares of Mid -day which will have is Radio business & License.

There is an opportunity to be made in this deal. The shares holders of Midday will get 2 shares of Jagran for every 7 shares along with shareholding in midday. The residual value of Midday after demerger of it Print business should be not less than 10 Rs. It is worthy to buy midday at this price for a better gain.

The valuation of the deal is as follows

CMP of Mid day             37.10        cost of 7sh   = 259.70
CMP of Jagran              125.00        cost of 2sh   = 250.00

Net pay off  for 7 residual share                                   9.70

Residual value of Midday   10.00         Price of 7sh = 9.70

Value of Residual value of Midday(9.70 / 7)            = 1.40
Net Pay off Per Share (10 - 1.40)                           = 8.60 (23% appreciation) 

It means if we buy Mid day today , the net payoff is Rs 8.60 per share if we value residual share of Midday at Rs 10 /-. (This is the minimum price, if look at Capex - Debt, The valuation is above Rs 18 )

Also Radio stock like RBN, ENIL have moved up because of Re - Ratings. (We can expect the same for Mid day 94.30)

If you are bullish on jagran , there is more compelling reason to buy Mid-day. Also there is a natural hedge in case of fall in price of Jagran.

The Caveats to this opportunity are
a) The Deal may take up to 3 months to conclude because of getting different approvals from government agencies.
b) There is a risk that price of Jagran will fall, as well as opportunity that it will go up.
c) Radio business of Midday is loss making and it requires huge capex.

If we go by valuations, It is a good bet and there is a money to be made in Demerger. Also the downside is limited because Jagran Prakashan is not expected to fall substantially, New Investor have entered in stock at 118 /-

Friday, August 27, 2010

Smart Order Routing : Endevour for Optimum Liquidity and Best Price

Smart order Routing refers to completing the orders using multiple exchanges in such a way that clients get its order completed at best price at a given time. It means client can get best price and liquidity using Smart Order Routing (SOR). 

SOR is an algorithm which takes into account 

a) Price of the Stock on All Stock Exchanges
b) Available liquidity available in stock on all stock Exchanges
c) Impact on price, liquidity  upon such order
d) Cost consideration for execution on particular stock Exchange (maybe different Charges, Rebates on particular stock Exchange, Brokerages, Statutory Cost ). Some may be true for India (Like Stamp Charges, Exchange Transaction cost)
e) It may also take into account different settlement modes (DVP, Counter Party, Spot, Dark Pools) and Settlement Conditions (T2T, Auctions)
f) Probability on likely execution (Price and Quantity) which may result in distribution of Orders.
g) Size of Order, Order conditions (Limit Order, VWAP, TWAP, IOC, GTC)
h) It may also look in some complex calculation of timing in case the broker has co-location in particular exchange.

After taking in account, the above mentioned points, it will release orders in exchanges in such a way that the client gets best price , grabs the required liquidity and volumes.

SEBI has allowed smart order Routing on Indian Exchange. This a natural extension of Algorithm Trading for Buy Side clients. This was expected from SEBI as Indian exchanges are liquid and has required  IT infrastructure to incorporate this facility.

The Salient features of SEBI circular on SOR are
a) This facility is available for all categories of Investors and not only Institutional Investors.
b) Any broker can offer this facility after taking relevant permissions from Exchanges.
c) Broker cannot be biased towards certain Exchange for order routing , and they have to be neutral.
d) Broker - Client Agreement has to specify use of SOR , along with its features, rights and obligations.
e) Brokers will have to maintain Audit Trail for SOR.
f) If client do not intend to use SOR and entering in contract it has to be documented. (To avoid future litigation)
g) SOR can only be used for recognised Stock Exchanges (To avoid Dark pools, trade by broker as counter party, Dabba trading)
h) Broker has to put proper Risk Management in Place
i) In case of any disruption in trading through SOR, broker will have provide its clients alternate trading mechanism.
j) This facility can be given through CTCL facility 

It is a right step for best execution of clients, but we would need clarity on below mentioned query 

It means Clients now need not specify the exchange it wants to trade in , but has to give order for quantity and price and SOR will decide the exchange to trade, which will fetch him best price for entire order.

The SOR is available to all client, including HNI and Retail Investors. Such investors do not mandatorily  take delivery on all positions and they may close their position intra day, What would be SOR guideline for such cases.

Monday, August 23, 2010

Ban on Mutual Funds to Sell options.

SEBI has banned all mutual Funds from Selling options. The takeaways of the circulars are

a) Any Asset Management Companies (AMC) or Mutual Funds cannot sell Options.

b) They cannot take positions more than its Net Assets even by buying options

c) Position taken in Derivatives segments, if hedge will lead to computation of Exposure for both sides (Eg. If a Fund is long on Futures and long on its put, both would be taken as different positions and not a hedging position

d) It expects AMC to give detailed six monthly reports on outstanding position held in derivatives position

SEBI came out with the order without taking any feedback from the Industry. There are several repercussions of the above order.

a) SEBI has bought these order as part of Risk Management of Mutual funds, but denying the opportunity to sell options completely is very harsh, there could have been limits, checks and additional margins to check excessive positions. 

b) The mandate of Mutual funds are Optimisation, The tools for optimisation, Leverage and Hedging is Derivatives. These tools are there in the market but unfortunately these tools are denied to specific class of Professionals thus denying opportunity to big class of investors who have kept their money in mutual funds and faith in the Professionalism of Fund Managers.

c) We all agree that trading in options needs Professional skill and Institutional players knows the Risks involved in taking positions in options(There is unlimited  loss in writing options) , whereas Individual players trading in options are more likely to have lesser or no knowledge of option trading . But still SEBI has deprived Mutual funds who are professionals. Individuals are allowed to trade in options after signing RDD (Risk Disclosure Documents) which says they are aware of risks of trading in derivatives.

d) The major players in option markets are Prop Desk, Mutual Funds and FII. (Insurance companies cannot trade). They provide liquidity and helps in price discovery process. With Mutual funds withdrawing  from selling options , FII would be in full charge of option positions (As Prop Desk are more involved in Delta Hedging and Arbitrage trade, also they have much lesser financial might compared to FII ) . It may also reduce liquidity in market in short run.

e) This ruling will be advantageous to FII, as they will be able to capture the market vacated by mutual funds, and they have natural advantage of taking positions and Hedging in overseas market (SGX, CME).

f) Instead of bringing  in complete ban SEBI should have come out with the names of mutual funds, whom they felt is taking risky bets by writing options and could have let the Investors in mutual funds decide about the risk.

g) SEBI is expecting Mutual funds to declare all their open position in their six monthly report as a measure of transparency, which in turn is also a threat to disclosing their open positions to the market, which can be disadvantageous and disastrous.

i) The points 7(d) and 9 are contradictory and needs clarity. 7(d) say you cannot hedge more quantity in underlying for position in Derivatives market and point 9 says excess quantity of position in derivatives market compared to cash market should be calculated for computation of Exposure. ( What about Delta hedge and Beta Hedge where the quantities would vary)

This order  is definitely against the Industry on the whole, Mutual funds are perceived to be professionals and SEBI wants to define them Rash and incapable. (Then should the Investors ever put money in mutual funds ? ), it is only paving way for bigger market share of FII and last but not the least it is a blow to investors of mutual funds and they are denied opportunity to optimise their returns on investments.

Wednesday, August 11, 2010

Release of Discussion Paper " Entry of New Bank in Private Sector" by RBI

Today RBI (Reserve Bank of India) released \discussion paper pertaining to issuing Banking license to Corporates/ Companies / NBFC..
This discussion paper is released by RBI to get feedback and suggestions from Industry, Corporates, Investors and Consumers. RBI intends to have feedback on

a) Capital Requirements of the bank
b) Shareholding structure of new banks (Promoters, Foreign Banks, Cap on shareholding etc)
c) Should Corporates and Industrial houses be given banking license
d) Can NBFC covert in bank or Promote bank
e) Business models of Banks.

We can say it intend to have feedback on ownership and guidelines of banks.
The Salient features of this paper is as follows

a) RBI feels the need for more banks in India and it feels that there will be ample business and space for all banks also after issuing new license but RBI is focused on financial Inclusion and inclusive economic growth.
b) RBI found that licenses issued in past had some lessons to learn. GTB became bankrupt, Centurion bank was merged. Yes bank was sold off by promoter. There were governance issues with Bank of Rajastan also small banks and local banks struggling to grow.

b) It feels that "Only those banks that had adequate experience in broad financial sector, financial resources, trustworthy people, strong and competent managerial support could withstand the rigorous demands of promoting and managing a bank."

c) Several committees have suggested Investment by corporates and Foreign banks be hiked from 10% to 15%

c) RBI is prepared to issue banking license to corporates, Industrial houses and NBFC to promote banks.

d) Dr Raghuram Rajan has suggested there need strict regime of Related party transactions, Lending in Group companies and concentration of Loans

e) RBI is wary of recent financial crisis and it want to avert any future crisis of such nature, it wants to avoid cascading and spill over effect of crisis of one bank to another and one corporate into a system.

f) It also gave banking scenarios in other geographies, broadly there is no restriction on percentage of shareholding by promoter (USA, UK, FRANCE, Japan and European union) or may need regulatory approvals.

g) The promoters of the new bank will have to mandatory list shares of the bank.

There are some issues for considerations which are

a) RBI is not clear on allowing banking license to Residuary Non banking company (RNBC), They may also ask for it (They are well networked) and they can boast of financial inclusion because they have penetration in Interiors and low earning groups .(Sahara and Peerless: I perceive they may also want a license)

b) India gives only full banking license, hence the business model will be universal banking and profit motivated but RBI can put restriction on percentage of urban branches and some control on lending

c) Promoters holding should be at satisfactory level to make them interested in business models and returns, 40% stake is an acceptable answers with lock - in , they should be allowed to buy shares to maintain stake holding in case of equity dilution. ( I am sure promoters would try to reduce stake in long run to capitalise the gains made on stocks

d) Only Corporates or NBFC be given license and not to any individual or group of Individuals who may have required domain and capital.. If Licenses are given to corporates, they should not have past issues in corporate governance (Not only the company, but whole group companies should be included)

I agree that banking licenses should be given to corporates and they should get same treatment and with other banks.

Now let us understand , How many companies are there in fray who have directly or indirectly said that they are eligible for a banking license or The markets perceive them to be a contender

a) IFCI 
b) Lic Housing Finance
c) Gic Housing Finance
d) Reliance Capital Limited
e) Shriram Transport Finance
f) M& M Financial Services
g) L&T Finance
h) Aditya Birla Nuvo
i) Srei Infra Fin
j) Religare Enterprise
The Capital Requirement of Rs 300 crores is very less and we will see the list getting bigger.

The hype build on share prices of such stocks should be looked it with pinch of salt because 

a) Getting a banking license will take another 6 months at least

b) Banking license will not assure good returns and there will be big gestation period

c) There will only be few license but the queue may very big (Beware there may be many who will just talk)

b) There will be many players in the fray (as with Telecom license) and Corporates / NBFC  may need capital, Expertise, Good background and political blessings.