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Stock Exchanges hold back Rs 40 crore payout to high net-worth individuals

Jul 032013

Stock Exchanges hold back Rs 40 crore payout to high net-worth individualsMUMBAI: Stock exchanges are holding back close to Rs 40 crore in payouts to several high net-worth individuals who are clients of a handful of brokers that are under investigation. Most of these investors have dealt with the wealth management division of the Mumbai-based brokerage Prime Securities, two sources with direct knowledge of the developments said.

Capital market regulator Sebi had directed the exchanges to hold back payouts of investors who had dealings with Prime which owes a large amount to the National Stock Exchange (NSE).

A few months ago, NSE had disabled trading terminals of Prime, but this was never announced by the exchange. NSE is yet to declare Prime as defaulter with the bourse not having completing its probe, said a source.

Market players said that Prime and a few members first faced trouble in December when eligible securities to be placed as margin with exchanges were changed at a short notice. Prices of stocks which could not be placed as margin dropped and some members were unable to further fund their trading positions. Such notices are issued from time to time.

Exchanges have identified funds flowing in through client’s code to differentiate between Prime’s proprietary investments and that of its clients. NSE is holding back around 35-37 crore payment to Prime’s clients.

Most market players think that punishing investors for the fault of a broker is unfair on the part of the exchange, but exchanges are defending the move as investigations are underway. The authorities are probing whether funds were linked to market manipulation and the possibility of related party transactions between Prime and a clutch of other brokers active in small- and mid-cap stocks.

Sebi has received complaints from other trading members alleging manipulation in certain counters.

Several small- and mid-cap stocks had crashed in January and February as brokers holding the scrips in lieu of margin finance deals started dumping them. Prime and a few other members placed these small- and mid-cap shares as collateral to trade in derivatives. But some were pushed to the brink of default as they failed to top up margins when the value of collaterals shrank.

More recently, it has come to light that some of the derivative deals in illiquid options were pre-negotiated funding arrangements that were routed through exchanges.

NSE trading positions worth around Rs 300-500 crore in the options segment under regulatory scanner

Jul 022013

NSE trading positions worth around Rs 300-500 crore in the options segment under regulatory scannerMUMBAI: Trading positions worth around Rs 300-500 crore in the options segment on National Stock Exchange (NSE) have come under the regulatory scanner on suspicion that these could have been pre-negotiated trades between buyers and sellers, said three sources aware of the probe under way by capital market regulator Sebi and NSE.

All positions being looked into are in deep-in-the-money Nifty call and put options of June and December 2013 expiry series. Though legally, nothing prevents anybody from buying or selling deep-in-the-money or far-dated options, regulatory concerns have arisen that the funds raised through the sale of these instruments may have been pre-negotiated. Another worrying factor was the possibility of default by the sellers of the options as the shares they placed as collateral with the bourse for writing the options may have dwindled in value.

What alerted the authorities was the fact that these options had generated significant participation despite their being of levels or strikes of 2700 and 8500, which are very costly and relatively less liquid than at-the-money or out-of-the-money options.

Till recently, it was learnt that NSE had withheld payments to clients of Mumbai-based broker Prime Securities, which owes money to the exchange, as margins (shares) the brokerage placed with it to take positions on equity derivatives had shrunk because of the fall in their prices.

Prime has moved the Securities Appellate Tribunal against NSE. Market players wonder why certain brokers have not been officially declared defaulters if they have failed to meet margin requirements. As per Sebi guidelines and exchange byelaws, any member failing to fulfill margin requirement at the time of inadequate collateral should be immediately declared a defaulter.

In derivatives trading, a buyer or seller bets on the future price of an underlying. Options are a form of derivatives instruments that are settled in cash in India. Exposure is taken in futures against payment of a margin, which is marked-to-market daily while an option can be purchased by payment of a premium.

Stockbrokers and derivatives experts say deep-in-the-money positions like the one seen in June and December series were nothing but financing deals using the exchange platform. Stockbrokers, such as Chetan Jain of Anand Rathi, say the financier (buyer) for such deals charges interest around 13-14% to the borrower.

The mechanics work like this. An entity needing funds sells a 2700 Nifty call for Rs 3,080 and an 8500 put for Rs 2,370 (both prices as of last Friday) in June to a buyer, earning a total premium of Rs 5,450. Both contracts expire in December. The maximum loss the trader will have to take if the Nifty trades between 2700 and 8500 (5800 range) is Rs 350 (5800-5450). This Rs 350, or 6.4%, for six months is the interest that the seller pays to the buyer. At end of trade, the funds (5450) are returned to the buyer.

The breakeven point – the level above which option seller will have to pay the buyer – is 5780 (2700 + 3080) for the call and below 6130 (8500 – 2370) for the put. So, if the Nifty closes at say 6000 by December, the seller pays the buyerRs 220 on the call and Rs 130 for the put, which is 350. If Nifty closes at 5780, the call expires worthless, but the seller has to pay Rs 350 (6130 – 5780) to the buyer on the put.

Since it is unlikely for Nifty to reach either 2700 or 8500 by December, this arrangement is ideal for such financing deals to be struck. The number of shares comprising Nifty outstanding on the 2700 call expiring in December was around 341,950 last Friday while that on the 8500 put was 247,200. Multiplying this with the premia gives the price the writers have made. As of last Friday, the outstanding positions were worth Rs 105.3 crore on the 2700 call and Rs 58.5 crore on the 8500 put.

Alook at the Nifty option data on NSE for December (as on last Friday) shows that the most active call was the 6500 strike Nifty with outstanding shares at 1,291,100 and the most active put is the 5000 strike with outstanding shares at 1,025,850. The premium on the 6500 call is Rs 94 while that on the 5000 put is Rs 58.