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Stock Market Operations

Notes these important linkages between global markets, increasing market liquidity and efficiency
and facilitating the flow of trade and finance.

11.4.1 Indian Market is not Ready for Derivative Trading

Often the argument put forth against derivatives trading is that the Indian capital market is not
ready for derivatives trading. Here, we look into the prerequisites, which are needed for the
introduction of derivatives and how Indian market fares:
Large market capitalization: India is one of the largest market-capitalized countries in Asia
with a market capitalization of more than ` 765,000 crore.
High liquidity in the underlying: The daily average traded volume in Indian capital market
today is around ` 7,500 crore. Which means on an average every month 14% of the country’s
market capitalization gets traded. These are clear indicators of high liquidity in the underlying.

Trade guarantee: The first clearing corporation guaranteeing trades have become fully functional
from July 1996 in the form of National Securities Clearing Corporation Limited (NSCCL).
NSCCL is responsible for guaranteeing all open positions on the National Stock Exchange (NSE)
for which it does the clearing.
A strong depository: National Securities Depositories Limited (NSDL), which started functioning
in the year 1997 has revolutionised the security settlement in our country.
A Good legal Guardian: In the Institution of SEBI (Securities and Exchange Board of India) today,
the Indian capital market enjoys a strong, independent, and innovative legal guardian who is
helping the market to evolve to a healthier place for trade practices.
Disasters prove that derivatives are very risky and highly leveraged instruments: Disasters can
take place in any system. The 1992 security scam is a case in point. Disasters are not necessarily
due to dealing in derivatives, but derivatives make headlines. Some of the reasons behind
disasters related to derivatives are:
1. Lack of independent risk management.
2. Improper internal control mechanisms.
3. Problems in external monitoring done by Exchanges and Regulators.

4. Trader taking unauthorized positions.
5. Lack of transparency in the entire process.
Derivatives are complex and exotic instruments that Indian investors will have difficulty in
understanding. Trading in standard derivatives such as forwards, futures and options is already
prevalent in India and has a long history. The Reserve Bank of India allows forward trading in
rupee-dollar forward contracts, which has become a liquid market. The Reserve Bank of India
also allows cross-currency options trading.

The Forward Markets Commission has allowed trading in commodity forwards on commodities
exchanges, which are called futures in international markets. Commodities futures in India are
available in turmeric, black pepper, coffee, gur (jaggery), hessian, castor seed oil etc. There are
plans to set up commodities futures exchanges in soya bean oil as also in cotton. International
markets have also been allowed (dollar-denominated contracts) in certain commodities. The
Reserve Bank of India also allows the users to hedge their portfolios through derivatives
exchanges abroad. Detailed guidelines have been prescribed by the RBI for the purpose of
getting approvals to hedge the user’s exposure in international markets.
Derivatives in commodities markets have a long history. The first commodity futures exchange
was set up in 1875 in Mumbai under the aegis of Bombay Cotton Traders Association (Dr. A. S.

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