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.

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