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Brokers get cold feet on futures

While broking houses refuse to fund clients in cash market purchases, they are lowering the leverage allowed in derivatives trades, reports Vyas Mohan.
Hindustan Times | By Vyas Mohan, Mumbai
UPDATED ON JUL 04, 2007 10:23 PM IST

Though the equity market's record-breaking spree has seen loud bullish calls from broking houses, there seems to be hidden apprehension on the street.

While broking houses in the country are refusing to fund clients in cash market purchases, they are also lowering the leverage allowed in derivatives trades.

Sources in broking circles said while cash market purchases of blue-chip shares had started receiving lesser funds from brokers, they were also refusing to put a penny in mid- and small-cap stocks.

It is learnt that on Wednesday, several investors were required to cough up funds to hold these stocks in their portfolios, failing which their stocks were sold without notice.

"Though the talk on the surface is of a bullish trend, which is expected to be fuelled further by corporate results, brokerages are not allowing clients to carry over cash purchases in mid- and small-cap stocks without paying the full amount," said a broker on the Bombay Stock Exchange.

Consequently, even as the benchmark BSE Sensex recorded a new high of 14, 880.24 points (up 0.50 per cent) on Wednesday, the BSE mid-cap index closed marginally lower, while the small-cap index closed almost flat.

According to margin funding norms laid out by the Securities and Exchange Board of India, a broker can fund the client up to 50 per cent of the purchase value. The client will be asked to produce additional money (margin) if the stock price falls by 10 per cent or more. However, in effect, many brokers are understood to be providing as much as four-five times the funding for such transactions, depending on their relationship with the client.

A high value of open interest (the number of open positions) and turnover in the derivatives segment of the National Stock Exchange and experiences in the past could explain the caution brokers are exercising now. Historically, high activity in the futures and options segment has always been a cause of worry for equity markets. Ahead of the last two crashes the market witnessed, the NSE open interests were at all-time highs.

While the value of open interest on the NSE stood at Rs 52,000 crore on May 9, 2006, when the market crashed, it clocked Rs 65,000 crore on February 22, 2007. On Tuesday, the value of open interest on the NSE was Rs 66,700 crore, the highest so far.

A high open interest signifies a huge number of leveraged positions in the market. In case of a fall, investors who are leveraged will be required to bring in money to hold their positions. Thus, the inability of investors to pay up additional margins in a highly leveraged market would see shares being sold in chunks by brokers, which pull the market further down.

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