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Rediff.com  » Business » Time to plug flaws in market system

Time to plug flaws in market system

January 28, 2008 11:39 IST

Warren Buffet's famous comments about derivatives as "financial weapons of mass destruction" reverberated through the street for the whole of last week, as a plunging Nifty and its troupe of plummeting derivative stocks drove home the point to thousands of clobbered traders.

For many of the Johnnies-come-lately, it was baptism by fire. Emboldened by the gains made in small caps in November and December, small time traders had trespassed into the big boys' alley of derivatives and had plunged headlong into stock futures. The sharp fall that began on Monday has wiped out all the gains some of them had made over the last few months.

Not a single tear need be shed for anyone who loses money in speculative activity like futures trading. However, one can educate new clients about the risks involved. Then, there are some systematic flaws that need to be plugged to better administer the modern day casinos.

A genuine complaint that investors have is that because the broker's terminal is allowed to only square up old positions, they could not buy at a time when values were beaten down, despite having a credit with the broker. I think it's time we had a uniform trading code, where a trader can trade with any broker without having the other do the due diligence of KYC norms.

The exchanges should let brokers know about any new margin requirement within half-an-hour of completion of post-closing trading. If the exchanges do not have the systems to meet this deadline, let them curtail trading hours.

I know brokers and exchanges themselves will never think of doing this because it will reduce their revenues. Once people get used to trading, the volumes should be back to the same levels, provided the exchange systems can process so many trades.

The exchanges allow brokers to accept stocks as security from clients. But they themselves do not accept their stock and want the broker to give his own stocks to the extent of 50 per cent of margins.

The other 50 per cent has to come through cash, bank guarantee or deposits. Either the exchanges should accept the client's stocks or stop brokers from accepting stocks as security and instead, insist on cash margins and police them effectively, with a stiff penalty for those who do not follow the rules.

You have a mini-Nifty contract which has 20 Nifties and then the regular Nifty contract where you have 50 Nifty as market lot. As there is no restriction on a well-heeled person to buy the mini Nifty or any curb on a trader with small means to buy the regular Nifty, I don't see any reason to have two separate Nifty contracts.

If the idea is to help the small trader hedge his positions through the Nifty, then that purpose is defeated as there is not enough liquidity in the contract and the impact cost is high. Why not have just the 20 Nifty contract?

Then there is an age old problem of strike prices not keeping pace with movement in stock prices. The new strike prices are opened only the next day and the reference point is the day's close, ignoring intra-day movement.

I can't understand this lethargy. If the idea is to avoid opening strike prices in case of freak trade and then make it mandatory that if 2 per cent, or any percentage that the exchange deems fit, volume happens then that strike price needs to be opened.

If that is not possible then let us have 10 and not just 4 out of money or in the money strike prices before hand, only so that it takes care of the present day volatility.

Systems are meant to facilitate the markets and not the other way round.

Vinod K Sharma in New Delhi
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