Recently, SEBI had announced the compulsory settlement of stock futures expiry by delivery for a set of 46 stocks where the regulator wanted to curb speculation. At the outset it needs to be remembered that this concept of compulsory delivery on stock futures will only apply to futures positions that are left to expiry. In case you reverse your stock futures before the expiry then there is no question of compulsory delivery. It automatically is cash settled. Even on the last day of expiry, if you revere your position then there is no question of compulsory delivery. It is only if you leave your stock futures position for expiry to be exercised at the closing price will it result in compulsory delivery.
Challenge is more in case of short futures
One of the biggest activities that happen in stock futures is the arbitrage activity. In this activity, the institution or proprietary trader holds on to the cash position and goes short in the stock futures position. The short futures position will result in compulsory delivery and will attract higher STT on the same lines as delivery transaction. That may go against the economics of an arbitrage transaction. Imagine a situation where you have sold futures and left it for expiry. However, you do realize that you do not have the stocks in your demat account to give compulsory delivery. The only option now is to borrow the stock from the market at a cost and give the delivery. That is where the SLBM could come in handy. That is why it said that the compulsory delivery of stock futures in select cases could emerge as a good reason for the development of the SLBM, where the stocks can be borrowed and lent easily using the market approved mechanism. Let us see how the SLBM can help the compulsory delivery of futures get a leg-up.
What is the Stock Lending & Borrowing Mechanism (SLBM) all about?
It is a system in which a trader can borrow shares that they do not already own or can lend the stocks that they own. Let us first understand how the SLBM works. The following are some of the key features of SLBM:
- SLBM has a fixed rate of interest and a fixed tenure. The maximum tenure is allowed to be 12 months from the date of borrowing the stock.
- When a trader is short on a stock (sold without delivery) and is not able to cover it, then the trader can borrow stocks in the SLBM and give delivery.
- The facility of short selling is available to institutional investors as well as to retail investors.
- SLBM also offers the owner of shares an opportunity to make some assured return which is totally secured as it is through the exchange mechanism.
How does the SLBM mechanism work in practice?
Let us assume that you are a trader who expects a stock to correct in the next 2 months by nearly 15%. An Rs.1000 stock becoming Rs.850 is big news for you, but how do you make money out of that. If you had the stock in your demat account then you can sell the stock and buy it back at Rs.850. You will reduce your cost of holding the stock substantially. But what if you do not own the stock in your demat account? The answer like in borrowing the stock under the SLBM mechanism! In this case, you can borrow shares from SLB and sell them back when the price comes down. Say you bought the stock and it went down by Rs.120 in 1 month. You are quite satisfied with the return of 12% in one month. You can buy them back at that point and book the profit. Of course, your profit will not be 12% because there is an interest cost for the SLBM borrowing and there will also be administrative costs to be borne. Still that will leave you at least with around 11% returns net of all costs.
When can you adopt the stock borrowing strategy?
This kind of strategy can be adopted under various circumstances. For example, you may expect the stock to announce disappointing results in the coming quarter. Alternatively, you may expect the industry down cycle to take all the stocks including this particular stock down. Or you may want to play the fact that the stock is in overbought zone and hence vulnerable to selling. In all these cases, if you don’t have the stock in your demat account, you can use the SLBM facility. The lender of the stock is not worried about how the price moves. As long as the fixed interest is available he is happy to make some money out of his idle portfolio.
Why delivery on stock futures may give a leg up to SLBM
It is expected that the regulator and the exchange will be compelled to develop the SLBM mechanism on a priority basis to make a success of the compulsory delivery on select stock futures. Otherwise traders may choose to compulsorily close their positions even at a loss to avoid the risk of auction of stocks. In a way, proper development of SLBM is good for markets as it can absorb shocks. People are not forced to offload their stocks in the event of downside risk. They can just borrow and sell the stock. And compulsory delivery on stock futures may just be the trigger for that!
Is SLBM facility provided by Tradeplus ?
The answer is “YES”. Tradeplus is one of the very few Discount Brokers in India to extend this service. IF you are a client of Tradeplus , you can participate in SLBM as a Lender or a Borrower. Check below some FAQ links on SLBM to understand more about the services provided at Tradeplus:
For assistance in SLBM email firstname.lastname@example.org