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.

Revision in PriceBands on NSE Cash Markets and Derivatives Markets

NSE came out with a revised guidelines for Revision in Price bands on Stocks Where there are no Price bands. The Circulars are (Here) for Cash Market and (Here) for Derivatives Market.

As per new guidelines 

a) Circuit will be opened only after there are at least 10 trades at Circuit Price.

b) The trades should also be from multiple Unique Client codes (UCC) on both sides.

With this guidelines the dynamics of Price bands would change, There will be many more Market Micro-structure issues which will come in to play which can be detrimental to smooth price discovery process.

The various scenarios where Price Discovery would be impacted are

a) What happen If multiple trade takes place in cash and price moves up in cash segment and 10 trades does not take place in FO market because of higher price in cash.

b) If I put to buy /  Sell  100000 shares of XYZ at circuit, then as per the circular, The Circuit would not open the circuit till I get 100000 shares and then another trade takes place (Multiple trades on both sides with different UCC )

c) If there is an upper circuit in pre-open session, the cash price would go up at the open of market, what about FO market ?

d) When a new future contract is opened, It calculates fair price using Base Price, If there is a big difference in Base price and traded price then , would Exchange still not open the band ? (eg India VIX far week contract)

e) The circular specifically says that 10 trades at price above 9.9 % with multiple UCC, Do NSE have liberty to open the band over ruling this logic?

f) What if 10 trades takes place in BSE and Not in NSE or Vice- Versa ?

g) Also If Price in Cash Market goes up, But not in FO because of Band, Will Options Bands be opened ?

The basic intention of Exchanges for such circulars was to reduce stray / Outlier trades, and It is tough for Exchange to allow dynamic price bands and alsoreduce wrongs trades which are also detrimental to price discovery.

But NSE can opt to issue clarifications to reduce confusion and for better price discovery of prices.

I have sent a mail to NSE, highlighting this issues and this write up should be taken positively for my endeavour towards better price discovery and lesser Distortion of Prices in Market.

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

I welcome your critical comments and suggestions.

Understanding the Basics for Trading VIX in India

National Stock Exchange of India Limited (NSE) is all set to launch trading on Volatility Index Futures (VIX) from 26th Feb, 2014.

Let us discuss about VIX Futures, Its trading, Advantages and  Lacunae(If any).

The Circulars pertaining to launch, Contract Specification and Settlement are (here),(here).

What is VIX ?

VIX  was launched on CBOE and it is their trademark (here). In India Volatility index(VIX) is a measure of Implied volatility on Nifty Options or we can say it the expectation of volatility for next 30 day. VIX is always calculated for next 30 day only.

VIX is calculated using Implied volatility (IV) of all out of money calls and Puts of Near month and Mid month of Nifty. To know more about computation methodology Refer (here), (here),(here).

Simply, VIX would be one number, which will help us look at the expected market volatility / Nifty volatility  for next 30 day. Eg: If there is budget / Result season next month, we can expect that number to be higher, as the market will be more volatile.

Can we trade on VIX ? Also some more details ?

Yes, We can trade in VIX futures in India. It will be available for trading on derivatives segment of NSE from 26th Feb, 2014. The Lot size of VIX will be minimum Rs 1 Million. VIX will be traded on derivatives segment of NSE. The contracts will have weekly settlement and there will be 3 weekly contracts available for trading. Effectively you can take a view of IV for 30 day after 21 days.

The final settlement of the contracts will be Tuesday's (I guess on other days, there can be impact of bias in IV, like on Friday late session, the IV tend to fall because of Theta value of weekend etc). The final settlement of VIX contract will take place on average VIX price of last 30 minutes of trading on Tuesday.

The Contracts are cash settled and the settlement will take place on T+1 basis, along with other derivatives contract. Also Spread contracts will be available for rollover.

The Margins on VIX futures would be at least 15% , But I believe it will be more (Up to 20% to 22%) because of volatile nature of VIX Futures. Also the benefit of spread margin will be available on VIX futures.

Also STT is also applicable on VIX futures, which will be same applied on Index Futures

What is the Use of VIX ?

a) VIX is used as a single number to predict the expected volatility for next 30 days.

b) It can be the tool for hedging.

c) It can be a volatile product to trade.

d) It also has predictive power on expected volatility

e) Historically It has negative co-relation with nifty futures. So If Nifty goes up, VIX tends to fall and vice versa.

f) Arbitrage is also possible both covered and Statistical.

How do we trade on VIX Futures?

a) Speculation : A Person can take a view on expected volatility and trade based on it ,Beware It will be very volatile, at least 5% a day.

b) Hedge : A Portfolio investor can hedge his portfolio by buying VIX (Inverse relationship)

c) An Investor can take position on VIX based on his Option Portfolio. He can hedge his gamma 

d) VIX futures is helpful in volatile times as you can take view on VIX, as VIX futures does not suffer decay (Theta)

e) An Arbitrageur can also indulge in spread trading on VIX futures.

What are the USP of VIX Futures?

a) There is higher volatility in VIX compared to VIX itself, Hence It is a volatile product which may lure traders.

b) Institution Investor are interested in VIX as a hedge, Thereby creating depth in market.

c) Cash Settled.

d) The computation of VIX is shown on NSE screen, every second.

Is there any Shortcomings / Lacunae in VIX Futures ?

a) It is very volatile product. On a single day, there will be moment of at least 5%, means a person can gain/ lose Rs 50,000/- in a day in 1 lot.

b) The Life of contract is very small only 21 days.

c) The expiration of VIX futures and Index Futures do not fall on same day, hence a difficult arbitrage.

d) Rollover will be very expensive as you will have to pay STT every week.

All in all , VIX is a new product to trade, but It is not meant for soft-hearted people. I feel that VIX futures will be Restructured in future to get broader participation. Also the Life of VIX futures needs to be increased. 

Also note that VIX Index or Implied volatility is always higher than realised volatility in normal times.

 

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

I welcome your critical comments and suggestions.

 

Rationalisation of Rules in Periodic Call Auctions for Illiquid Scrips

Today SEBI came out with revised guidelines for Periodic Call Auction (PCAS) in equity market (Here).

Also before we understand, what changes are done and how it would impact the stock criteria, I would request you to please refer my previous blog on this topic for smooth continuation (Here).

With this circular, SEBI has rationalised criteria for stock becoming eligible for PCAS. Effectively SEBI has bought down the eligible universe to only small cap and illiquid stocks.

Impact of New Circular :

a) All Stocks which has a daily turnover of more than Rs 1 Million will not come under PCAS. (Effectively SEBI has moved from selection criteria of Quantity and Number of trades to Value of trades. A very rational move)

b)  All Stocks which has a market cap of more than Rs 10 Crore will not come under PCAS.

c) All consecutive dividend paying companies will not come under PCAS (For last 2 years out of 3 years)

d) All companies which are profitable consecutively will not come in PCAS (For last 2 years out of 3 years) along with less pledge of share (Not more than 20%)  and Book value of more than 3 time the face value.

e) Previously If stock goes in PCAS, It has to be in PCAS for 2 quarters, which is now reduced to 1 quarter only

f) All Un-executed orders in PCAS can be carried forwarded to next PCAS auction for same day.

Well, SEBI has effectively kept only small cap, penny stocks in PCAS, Which are illiquid and also non profitable in the ambit of PCAS. So most of the stock will be out of PCAS now. 

So now PCAS will be a dead segment and now It will die a natural death in long run, because now there wont be many companies in PCAS and they would be very illiquid.

As stated in my previous blog, SEBI has to make amendments in rules of PCAS segment, but now they have liberalised most companies out of PCAS

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

I welcome your critical comments and suggestions.

 

Periodic Call Auctions for Illiquid Scrips

SEBI recently came out with circular (here) asking exchanges to transfer all illiquid stocks in call auctions from 1st April, 2013.

In this circular SEBI has said that

a) Allow Pre-opening Session in all liquid stocks.

b) Transfer all illiquid stocks in Periodic call auction.

From 1st April, 2013 all stocks, if they are liquid, would be available in Pre-opening session, which is a welcome move.

Also all illiquid stocks will be available only in call Auction. Let us first understand the meaning , features, advantages,dis-advantages and deficiency  of Call Auction and also its impact on price discovery.

What is Call Auction ?

Call Auction is trading mechanism where all buy and sell orders are pooled together and trade takes place at a equilibrium price at which maximum buyers and sellers are ready to trade. There is only a single discovered price for every call auction. The Price discovery process for call auction is same in Pre-opening session, except that you have more time for order placing, modification and cancellation.

There are around 260 Stocks which are illiquid as per latest NSE circular.

What are Illiquid Stock :

Illiquid stocks are stock which are infrequently traded and generates lesser trading volume. Generally stocks which have low equity, low Floating stocks , Stable stocks, or the companies which do not have more of speculative interest are mostly illiquid stocks,  but we should not infer that all stock which are illiquid are not fundamentally good companies. That may be true for some companies.

NSE criteria for illiquid stocks are High Bid - Ask Spread, Low Volumes, Higher Impact Cost, infrequent trades etc. SEBI has defined a broad criteria that Stocks which have average daily volumes of less than 10000 shares, and which have daily average of less than 50 trades are considered illiquid on all exchanges where the stock is traded. 

When would a stock become liquid from illiquid :

When the above mentioned parameter are not met by stock, it becomes liquid stock and it will be transferred to normal segment, but once stock becomes illiquid, it will be in call auction category for at least 2 quarters

The Salient Features of call auction as per SEBI circular are :

a) Call Auction for illiquid stocks would take place every hour during trading session. Out of 1 hour, 45 min will be allowed for order placing, next 8 minutes will be for order matching and last 7 minutes will be buffer / cooling off period. To avoid fake orders to distort price, the closing time of call auction will be random between 44th and 45th minute.

b) After the closure of each call auction, pending orders will be purged / cancelled.

c) Price bands will be applicable as per Risk Management rules of exchanges and It may also settled on trade to trade basis.

d) There is penalty on people generating false volumes by simultaneously being a buyer and a seller at the same price.

Are there advantages of Call Auction : Yes

a) Call Auction leads to better price discovery , also thereby reducing outlier trades.

b) A bigger order book can be generated using call auction.

c) It reduced volatility in stocks due to illiquidity.

Are there any Dis - advantages / Lacunae in Call Auction :

a) The Computation for Illiquid Stock of SEBI is flawed, because it looks only at volumes and not on any other parameters like Bid - Ask spread, Impact Cost etc. Most High value stock would tend to become illiquid as they may not pass the test of average 10000 shares

b) There are many prop desk who have different people working at different locations and on different strategies at the same time on different mandates, also their decision making is decentralized. They may also have Chinese wall between traders. In such scenarios it may happen that some trader at one office of a prop desk may be selling that stock and another trader of that same prop desk may be buying at the same time. Though such trades may not be artificial volumes but such trades will attract penalties.

c) The pending orders are cancelled after every call auction, hence a buyer or sell will lose his priority in case of UP or Down circuit. Also it will be cumbersome to give new orders and track trades after every call auction.

d) Intraday trading in this stocks will be marginalised.

e) Margins will be higher in call auction segment comparatively.

f) Disclosed quantity in orders are not allowed in call auction, hence bulk order and block orders will be disclosed in market before the deal taking place, which may put parties looking to buy or sell big quantities in disadvantage.

Once the bulk order or block order is discovered on stock, many traders would try to create nuisance value. The traders would try chasing the bulk or block deal.

Conclusion : Call auction are there in many international market and academics prefer call auction to normal trading in illiquid stocks and I would need to read more of academic papers to speak on international experiences. But I would like to put suggestion and experience about the same

a) Whenever in India if a stock is transferred in T2T segment, the stock most of the times tend to drift downwards, because liquidity players would not give quotes, Call Auction also reduces speculative element from such stock. So maybe we can see the price of stock always trading at discount to its fair value, till the time it is traded in call auction.

b) Can we look for Market Maker in such illiquid stock rather that trading in call auction. Many developed markets including US prefer market makers.

c) There is only one stock as of now which is listed on SME segment of exchanges, there is hardly any volume in the stock. These stock is only traded in call auction, can we get a pre-cursor of the happening. I would want to qualify that the view can be biased as there is only one stock as of now.

We should be happy that SEBI is working for better market place and  I am sure we can expect some amendments in current call auction procedure to make it more market friendly

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

I welcome your critical comments and suggestions.