Thursday, March 21, 2019

Valuation of Vodafone Idea Lmited Futures in case of Rights.

Vodafone Idea Limited (Idea) came with a Rights issue of massive 25K crores. The rights will be subscribed by Vodafone and Idea. Also any unsubscribe portion will be subscribed by promoters.

I am writing this blog not to discuss the valuation of the company but the valuation of its futures in Derivatives segment. It is my endeavor  to highlight the valuation of this instruments in this special situation.

Background : CMP of Idea is 33.30, March Futures is 31.95/-,  April Future is 29/- and May Futures is quoting at 26.55/-. The Ratio of Rights is 87 : 38 shares. 

I have received suggestions to buy Cash and sell May futures (though it is quoting at a very big discount ). The rationale is that the rights is @12.50 and since the issue is very big and in a beaten down sector there can be over-allotment.

Rather than commenting on strategy, if it is a good idea, I will jot the facts on valuation (Futures Prices) in front of you and then you can take a conscious decision.

Valuations : For every special situation rights like Rights, there will be corporate benefit in derivatives segment of NSE. The corporate benefit price is derived from Closing Cash price of Stock on eve of Ex-date.

I may not know the closing price of 29th Mar, so I will base my valuation of futures (Corporate action price ) at CMP.

Based on CMP, The Adjustment factor is 0.57, so the new
a) Lot size can be approx(21230)
b) Ex rights price will be 18.82/- (March Futures will not exist on Ex date)
c) Ex-right April Fut Price will be 16.45/- (29*12000/21230)
d) Ex-Right May Fut will be 15.01/- (26.55*12000/21230)

Interpretation :

So when you are buying shares @33.30, your cost (effective cost after rights) is 18.82.

Now if you sell May futures @15.01, effective price after adjustment. You will be incurring a straight loss, but there are high probability of over-allotment.

To reach a Break-even point (BEP), You may need an extra allotment of 168 shares for every 87 shares. It means you will need an over-allotment (1.94 times , Total allotment of 2.94 times).
(I am not considering Brokerage, STT, Statutory charges, Interest, Margins cost)

There seems optimism on over-allotment and I may not know if all institutions will apply/ over apply, as Retail / HNI shareholding is comparatively small.

I am only covering Futures pricing. Option pricing will involve different calculation.

I welcome your critical comments and suggestions.

This is not a recommendation to anybody whatsoever to buy OR sell any share, but it is my thought process and views on this topic.

PS : I will try to write blog at shorter frequency.

Tuesday, April 24, 2018

Physical settlement of derivatives : issues and solutions...

It is Easier said than done.....

SEBI has said, It will comulsory implement Physical settlement of Stock Futures in a calibrated manner. (Here)  The intentions are noble and its a global practice.

The volumes on exchanges have extrapolated since the advent of Derivatives. It grew even more with advent of Stock Futures, Stock Options and Weekly Bank Nifty Options. One of the reasons for a rise in the volumes was simple product.

With change in Settlement process from cash to delivery, it may change the paradigm and valuation of derivatives product. We will here see regulatory challenges and possible remedial action. This discussion is to see a gradual transit without impacting volumes.

a) There is concept of Trading Members(TM), Clearing Members(CM) and Professional clearing Member(PCM). When there is a physical setlement, how would the billing be, also Pay-in  / Pay-out of Funds and Securities. (Current systems involves only money but If stocks are added, Risk will be become bigger for CM and PCM).

b) Risk of Assignment : As of now only In-the-Money stocks are assigned / Exercised and So the writer is aware of probabilty of assignment, but when the delivery is physical, there will be an unknown probability of assignment in Out-of-Money options also. (It should be remembered that Stock Options was changed from American type to European Type exercise for the same reason).

MCX has a different way to mark delivery as delivery period is for a few days, which is not possible in Equities, so there will be a  risk of assignment on option writer for OTM option and non-assignment for ITM options.

Corporate Action : As of now, Corporate actions are cash settled for Dividend, Rights, Bonus. There can be issues now, as participants may ask for shares or would be ready to give shares in corporate actions. (That can be taken care by defining rules, but that may lead to temporary mis-pricing.)

Settlement : As things stand, there can be different settlement for expiry, I dont think, there will be a bigger settlement on expiry, Which will also mean, there can be fall in volumes, which may also reduce liquidity.

Securities Transaction Tax: This is the trickiest thing for physical delivery, This will have to be tweaked by Finance ministry to align with delivery STT, else We will be able to buy / sell stocks using Futures and Options without paying STT.

Seller participants will pay only 0.01% on selling only and nothing on buying, Also only the participant exercising the option pays STT and writer won't. This anamoly would be used to reduce STT outflow. I am sure this anamoly will be fixed, but that will be at slower pace, as it involves Finance ministry and STT may appear only in the budget fot next year.

It is a welcome move, but These  issues need to be resolved for smooth implementation of physical settlement.

a) let the settlement of stock futures be carried in next day trading in cash market, if that happens, all participants with open positions will have an opportunity to cover / close their positions.

There will issues in such implementation, but that will be only once. I am sure, it will help traders from not shying away in settlement days, inturn reducing volatility and mis-pricing.

PS: By bringing physical settlement, SEBI has closed the door for overseas stock futures mkt. If ever they are traded overseas , it will be a different product, just like NDF( Non deliverable forward) traded on Indian rupees.

Want to write more, but will do it via another blog.

I welcome your critical comments and suggestions.

Monday, February 27, 2017

Introduction of Graded Survelliance Measure (GSM) by Exchanges

SEBI, NSE and BSE are working hard to curb price manipulation on Stock Exchanges. There are also instances resulting in Tax Evasion using methods of Price-Rigging. In the past, Exchanges had put Risk- Management practice of declaring Illiquid Stocks, Periodic Call Auctions, Reduction in  Daily Price Freeze, Transferring Stocks in Trade-to-Trade Segment, Weekly/monthly/ Quarterly / Yearly Price Freeze etc

To further strengthen the Risk-Management and to Discourage Price Rigging and Tax-Evasion, NSE and BSE came out with another Surveillance measure "Graded Surveillance Measure (GSM)". The detail of circular are NSE here and BSE here.     

The Highlights of GSM are

a) Any abnormal price rise not commensurate with Financial health and Fundamentals like Earnings / Book Value / Fixed Asset / Net-worth / PE etc. will be identified.

b) All such identified stocks will be put in T2T with addition surveillance deposits of 100% or 200 % in Cash only by the buyers.

c) If after some time of imposing Additional surveillance deposits, The stocks remains volatile, They may be traded once weekly / Monthly and maybe with a ban on any further Price Rise.

d) The stock eligible for GSM will be identified from time to time and will be reviewed on Quarterly and Six Monthly basis. 

e) Additional Surveillance deposit will be credited only after quarterly review and It wont be refunded before quarterly review, even if the bought stock is sold in market.

The Points to ponder in this circular could be :

a) Exchanges want to curb the price rise and manipulation but hypothetically if GSM is declared in a particular stock, What may happen ? The buyers in such stock will vanish and also we may see many seller in the stocks.. but then who will buy? As buyers will have to pay additional surveillance deposits and may also probably get inquiries from stock exchange for buying. 

Then why would anybody buy that stock and If nobody buys it, price will also not fall. Also Volumes will dry and minority investor will be struck.

b) The Additional Surveillance deposits is payable only by the Buyers, and the Sellers rights are unhindered. It does not matter that sellers now were not selling when the price was rising,  also it does not  matter if the sellers are the promoters / operators along with other shareholders. They will get their money on payout.

c) As per circular, The criteria for stocks falling in GSM are conventional methods of Earning, Book Value, Fixed Assets, Net-worth , P/E etc but Are this criteria sufficient to decide if the stock is over- valued ? What about future expectations ? Higher valuation because of M & A target ? What about written down assets ? What about Investments of holding companies ? Expectation of some News / Orders / govt relaxations ?

There are different parameters to evaluate companies of different sectors and many Sectors have their unique valuation parameters . So GSM criteria can be biased on both criteria of escaping the GSM (IF accounts are manipulated) and Falling under GSM (If the companies have value but under different valuation model accepted in that industry).

Moreover GSM have yet not laid clear-cut criteria for stocks falling under it.

d) Since GSM have not laid clear-cut criteria for Stocks falling under it, There are probability to evaluation on Case-to-case basis and which may lead to decision based on perception of Risk Management officer.

e) Once the stock rises for few day, there will be fear of stocks coming under GSM, which may lead to players avoid the stocks and person who may be privy to news in such companies can make super normal profits.

f) Stocks however good, but once it falls under GSM, they may be tagged as tainted and will be avoided by traders.

g) Positively, If Risk-management is taken care using GSM, it makes a case for Weekly / Monthly / Quarterly / Yearly  circuits to go as unwanted price rise will be taken care by GSM.

i) The biggest impact may be on Small-caps and Micro-Caps.

I believe, Exchange will come out with more clarity and transparency on criteria for stocks falling under GSM, So that retail investors / Traders / Jobber / Market makers can avoid such stocks or exit from such stocks which can come under the ambit of GSM.

Bottom-line : GSM will suck liquidity from stocks and exits will become difficult.

This is not a recommendation to anybody whatsoever to buy OR sell any share, but it is my thought process and views on this topic.

I welcome your critical comments and suggestions.

Tuesday, June 21, 2016

SEBI Buyback Guidelines : Opportunity in National Aluminium

Business Schools taught us , Companies do Buyback of Shares to enhance shareholders value. But because of  Budget,2016 and New SEBI Buyback Guidelines , There are new reasons for buyback.

a) Do buyback instead of paying Dividend to avoid paying Taxes.
b) Do buyback to use company reserves for funding needs of Promoter / Government. (Instead of OFS)

I am writing this post on calculated risk  / Low risk Arb opportunity. Discussing on implication of Buyback with above rationale can be by another blog.

There are spate of Buyback happening in the Indian market by Private Sector companies and Public Sector companies. There is SEBI guidelines that Buyback from Small shareholders (Holding shares valued at not more than Rs 2 lacs) should be made as per there entitled share holding ratio or 15 % whichever is higher (Refer SEBI guideline linked above).

It is noticed that small shareholders may form more than 90 % to 95 % of the number of shareholders, but they may not hold more than 5% to 10% of the share capital. Also Higher the promoter holding, lesser will be holding of small shareholders in percentage terms.

It means the lesser the percentage of Retail shareholding, Higher will be the acceptance ratio in Buy back., Also there will be many long term investors, who would not want to tender the shares (Also sometime, they wont, if their cost of purchase is higher), which will further push up the acceptance ratio.

There will also be many big Investors, who would not participate in such arb trade, they may not be able to buy such quantity back from normal market without impacting prices. There will also be large investors, who would not participate in Buyback as Arb returns may be lesser than Tax impact on selling of shares.

Private sector companies like Wipro, Bharti Infratel, Novartis came out with Buyback, They are doing buyback of shares, but Promoters are also participating in buyback, clearly with an intention to get money from the company and in more Tax effective way.

Recently PSU like National Aluminum (Nalco) , MOIL and NMDC have declared Buyback, The Buyback seems done only to give reserves back to promoters (Government), participation by other shareholders in collateral.

But There is opportunity for small shareholders based on acceptance ratio. I will not calculate returns but try to calculate acceptance ratio.

I will discuss my rationale of Buyback opportunity in Nalco  below as they have already asked for Postal Ballot.

National Aluminum : Nalco is a profit making, dividend paying PSU, It has a dividend yield of almost 4 %, and trades at PE of 15. Its book value is around Rs 52/-. It has buyback of Shares at Rs 44/- (CMP 41.50).

We will look at share holding Data, to arrive at acceptance ratio.

No of issued Shares
% of Promoter holding (GOI)
No of small shareholders
Qty held by small shareholders
% of Qty by Small share holders
Total Buyback qty
% of Buyback
BB Qty for Small Share holders
in Buy back

Fund holdings
Fund holdings %
Other Major Shareholders
Other Major Shareholders %
BB Qty for Goi
BB Qty for Other Share holders
Total Floating Stock
Total share by large share holding,

more that 1 %

From the above table, we can see that, there is high probability of 100 % acceptance ratio for small share holders, If it is bought now also, because The offer is to buy more than 9.66 crore shares and there are only 5.28 in that bracket. 

Also as LIC, Bajaj and Hindalco hold chunk of 26.54 crore share, which I feel will mostly not be tendered in Buyback. Also if we remove all Institutional shareholder and Share holder, the remaining float would be 118406554. Whereas Buyback qty is much more.

There can be change in acceptance ratio if Price falls, but then fundamental will come into play and many value buyers will enter the market to support the price. Also to qualify GOI have put its intention to tender 100 % qty of Buyback, (That may happen if price of Nalco move above 44 /-)

I will calculate acceptance ratio of other companies as and when they finalize their buyback QTY and Price, and send it for approval of shareholders.

This is not a recommendation to anybody whatsoever to buy OR sell this share, but it is my thought process and views on this company.

I welcome your critical comments and suggestions.

PS : I have some position in the stock, So I can be Biased

Sunday, December 6, 2015

Can Additional Periodic Pice Band on BSE distort Pirce ?


Recently BSE Ltd (BSE) came  out with Additional periodic price band (Here) for stocks exclusively listed on BSE.

Every Stock traded on stock exchange has a price band, wherein it can be traded for a particular day (Except for stocks in Derivative segment). But now BSE has put a Weekly / Monthly / Quarterly and Yearly  price-band on all stocks listed exclusively on BSE. It means the stock cannot move up by certain percentage in that time frame. The price-band is mentioned below.

Securities with daily price band as
Weekly   Price Band
Monthly Price Band
Quarterly Price Band
Yearly Price Band
+/- 60 %
+/-100 %
+/-200 %
+/-400 %
+/- 30 %
+/-60 %
+/-100 %
+/-200 %
+/-20 %
+/-30 %
+/-60 %
+/-100 %
+/-10 %
+/-20 %
+/-30 %
+/-50 %

Please note that there is no restriction on fall in price, The price can fall by 100 % i.e,  the fall n share price can be up to 0.00 in a year.

Image result for bse logo

The Exchange quotes

"In order to enhance the market integrity and to prevent excessive price movement in the securities listed on its trading platform, BSE as a pre-emptive surveillance measure has an additional framework of periodic price bands in addition to the aforesaid daily price band framework. These additional periodic price bands shall be applicable to securities exclusively listed and traded on BSE Equity Trading Platform including securities listed on SME and SME ITP platform. The periodicity of these price band shall be weekly, monthly, quarterly and yearly"

The features of the additional periodic price-bands as per BSE are as follows

a) It is applicable only on Exclusively BSE listed stocks.
b) It will enhance market integrity.
c) It will prevent excessive price movement.
d) It is applicable to all stocks including SME and SME ITP platform.
e) It will help in surveillance mechanism on Exchange
f) Any up-move in S&P Mid cap Index will be adjusted in price-band by 2X
g) In-case of Corporate action, the price will be adjusted accordingly.

The added features cited by BSE are
a) It will reduce money laundering.
b) It may reduce volatility in such stocks.
c) It will reduce stock rigging.
d) They have also said that If there is upward change in daily circuit percentage of stock, the Additional price band will be increased, but if the circuit percentage of stock is decreased, the Additional Periodic price will remain the same. (Here)

But, There are many Drawbacks, which BSE needs to look after bringing in the additional price bands :

a) IT WILL DISTORT PRICE DISCOVERY : Additional periodic price bands will distort price discovery, because now, it does not matter, if the fundamentals of the company deserve to get re-rated on the higher side.
But if there is negative re-rating, the price can fall up-to 0.00 in a year.

b)  It will reduce volumes in such stocks : If the stock comes in the ambit of additional periodic price bands, It will be locked in upper circuit and thus it will reduce volumes in stock and also it will mean loss of interest by traders to trade in such stock.

c) Rise in Bid - Ask Spread : Such loss of Interest will also increase Bid / Spread in Stock, Which means such stock will have to pay liquidity premium.

d) Advantage for sellers : If the stock price reaches yearly price band, Then the price will not be able to move up, Hence it will compel the investors in such stock or some who can borrow such stocks, to go short on that stock as Price cannot not go up because of band for next 8-9 months. He can cover the position, when the price comes down. Also if he covers the short at the end of year, at same price, he will earn interest on money recd from short selling.

It will be more like Put option on stock, available at free of cost because of upper price band.

e) In-fact Gullible investors can be struck at circuit, waiting to sell at higher price and it may happen that they may not be able to sell the stock at higher price because of such bands.

f) Volumes will migrate to other exchange : Stocks which are listed on NSE exchanges does not fall under the ambit of Additional periodic price band, Hence Investors and Promoters will prefer listing on other exchange also, it may mean shift in volumes to other exchange

g) There are many stocks in price circuit limit everyday, but volumes can happen only at previous day circuit price of lower than that, The list will start getting bigger with time when many stocks will fall under yearly bands.

Some Things to Ponder for BSE

a) SEBI may have asked exchanges to find ways to curb money laundering  and Price Rigging on Stock Exchanges, But I don't think It is a proper way to curb money laundering or Price Rigging. Its just penalising all stocks for exchange incompetency. I am sure, Exchanges have resources to discover money laundering and Price Rigging by ways of Risk  management and also data mining. They have access to all order and trade data, KYC of Clients,  also they can ask for depository data. I am sure mining that data will lead not only to cases of Money laundering , price Rigging but also Front Running. Also new listing regulation can make Exchange more powerful in getting information from Companies also.

b)Why NSE has not put Additional periodic price Bands in place ?

c) Volatility is expected in trading, Exchange is not in business in reducing volatility, but they have put in place proper margin and Risk Management to take care of any eventuality. Volatility is because of uncertainty, Exchange can try only smothering  price discovery process.

d) Price of stock changes with change in Fundamentals and Sentiments. In a bullish scenario, if a company is doing well, Investors will buy the stocks, but if they are struck with price band and then there is change in sentiment ? 

e) SME stocks and SME ITP stocks are on different board, here exchanges may not have sufficient data on such companies, and it may be more difficult to bring in transparency in such stocks because of small size, but Main board has many more laws to keep tabs on company.

Additional periodic Price bands from the academic point of view :

a) Exchange has put in an additional impediment in price discovery process of stock. They have tweaked with market micro-structure, which is biased to sellers.

b) Many Stocks were transferred in PCAS (Periodic call auction) in the past, but SEBI had to later relaxed the criteria for PCAS stock, which meant most stock were out of the ambit of PCAS.

c) I am not aware if BSE has done some research work with the help of academician before implementing Additional price band. If at all, it is done, It can put it in public domain.

d)  Will Additional price band, compel companies to list on NSE, no matter if that means increasing compliance work. or Listing on NSE and doing away with BSE

e) Will Additional Periodic price band impact price discovery on upside ?

Looking at price and circuit data on BSE, I can pen few points 

a) BSE can enhance its surveillance to deal with price rigging, Money laundering and Front running. (In-fact it can take help of academicians and also NISM ( A initiative of SEBI) in dealing with huge data.

b) Exchange may lose volumes and more people will prefer to deal with stocks listed on NSE (Maybe many companies would then prefer to list only on NSE)

c) Investor may just watch rally in market and sit tight with stocks in circuit because of additional price band, later they may regret if there is change in sentiment.

d) BSE may keep additional price band for SME and SME ITP stocks and for others in the past they may reduce price bands to 2 %.

I guess BSE should not wake-up only after some high volumes stocks with institutional interest comes in Additional price Bands and they face wrath / Lobbying of such Institution. ( I guess Spicejet is nearing that level)

Till then on the softer side  " No Investor will be able to hold micro-cap Multibagger stocks in exclusively listed BSE stocks because of these rules "

I am highlighting this issues and this write up should be taken positively for my endeavor towards better price discovery and lesser Distortion of Prices in Market.

This is not a recommendation to anybody whatsoever to buy OR sell any share, but it is my thought process and views on this topic.

I welcome your critical comments and suggestions.

PS : I may have position in stocks or intending to take position in stocks falling under Additional periodic Price Band of BSE.