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.

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.

Suggestions:
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.

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.

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
20%	+/- 60 %	+/-100 %	+/-200 %	+/-400 %
10%	+/- 30 %	+/-60 %	+/-100 %	+/-200 %
5%	+/-20 %	+/-30 %	+/-60 %	+/-100 %
2%	+/-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.

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.

Introduction of Futures and Options on Global Indices on NSE

As per SEBI guideline and permission, NSE is set to launch Futures and Options contracts on " S&P 500" and only futures contracts on "Dow Jones Industrial Average" (DJIA).

Now instead of Tracking these indices and taking queue over here, we might as well trade on such indices or hedge on such indices.

Before discussing the impact of such indices, let us understand its features.

S & P 500 DJIA How it will show on NSE F&O Screen FUTIDX S&P500 FUTIDX DJIA Lot Size 250 25 No of Contracts available 6 6 M1, M2, M3,Q2,Q3,Q4 M1, M2, M3, Q2,Q3,Q4 Expiry 3rd Friday of Every Month 3rd Friday of Every Month Last Trading Day Same day as Expiration Same day as Expiration Settlement Cash Settlement Cash Settlement Underlying Currency Indian Rupees Indian Rupees Types of Option European Not available Margins Span Margin Span Margin Settlement Price Opening Price of S&P 500 on CME Opening Price of DJIA on CME There are several Advantages of trading in Global Indices in India They are mentioned as below a) S&P 500 would be traded on stock Exchange outside USA for the first time. This would also enable many FII to take position in India but as of now only Resident Indians as per SEBI guidelines can trade. b) This will enable investors to take positions or Hedge on International markets. c) Simplicity : It is simple as we trade in nifty as the underlying is traded in Indian rupees. There is no currency exposure. d) Easy Access : It will give easy access to all investors in every part of the country. e) There is a facility to see live quotes of CME to take position. f) There is trade and settlement guarantee fund of NSE, which will enable security of our settlement. g) New strategies can be introduced in market based on Nifty, DJIA & S&P 500 and its movement and correlation h) Updates on development in these index will help up see broad trends of industry globally. i) There are benefits of cross-margin between  DJIA and S&P 500. There are some thing to be understood before trading a) You will have to pay taxes and STT as per Indian law only. It may lead to price distortion between prices in India and abroad. b) The Settlement price of these contracts are computed based on opening price of all its stocks. That is termed as SOQ( Special Opening Quotations). Please understand that opening price of Index is not same as SOQ price. there is a slight difference.      Normally when market opens we get quotes and opening prices at the open of trading but there would be some stocks which will trade after some time may be minutes or after an hour. In the meantime there may be many prices which would have been derived on DJIA and S&P 500. What SOQ does is, it considers opening prices of all its constituents, (though they may have been traded after some time) and derive a opening price such price is called as SOQ prices which would be the final settlement (we will discuss more on rationale of SOQ later).     What it also means that if you have position at the close of settlement, you are not aware of the settlement price till the opening of American markets and then only you will know the settlement price which may be different from Dow futures or S&P futures which you may see our market times. c) Initially there wont be participation of FII in these segment of market and as such there wont be a live trading on underlying which may result in illiquidity, higher bid-ask spread, outlier trades. d) Trading in DJIA and S&P is almost 23 hours, because there are 2 types of trading on CME. a) Pit Trading and Globex (Electronic Trading. These electronic trading system is open for 23 hours.) but there will be problem of liquidity on these exchanges at odd hours (when there is night is USA and we Trade.) To sum it up, it add one more tool for trading in our arsenal but we may play blind bets on overnight positions where there will be volatility in that market and the price will change over there and we will only be the price taker at the open of trade over here. Some more FAQ, if you are not bored : a) How do we trade : It is on individual preference, but as mentioned price discovery on underlying will take place only in American markets, when our markets will be closed. The initial strategy would be to trade by taking positional view on these index (may be for 3 - 4 days) or create a hedge for position in Indian assets. b) Why is the final settlement at the opening price ?                                              There are market makers / Specialist in that markets appointed by the companies and Exchanges. These market makers / Specialist are obliged to give quotes during the day and absorb all demand and supply of individual stocks. So when the market opens these people absorb all demand and supply at the opening price with the obligation to make sure that there is lowest possible drift from previous closing price. Because of these, arbitrageurs in that market who have positions between underlying and Index buy / Sells at opening price to track SOQ prices. Opening price in such markets is a good indicator.(of overnight information change, overnight  liquidity needs and Noise (Fama))These prices are equilibrium price as it absorbs all demand and supply at the open.and If we compute the opening prices of all such underlying stock we get SOQ which is perceived to be a good and equilibrium opening price. Many other exchanges in America (like CBOE) use SOQ prices for settlement. c) How about trading in Options : You can trade in options only on S&P500. The queue of Implied volatility will come from CME only and the would be little higher in India (because of Illiquid Indian markets for these products)  .     In the Money calls will be cheaper (because of higher STT on Exercise). Also the cost of adjustment will be higher because of bid  ask -  spread. I welcome your comment, suggestions and queries.