Options

After SEBI standardised lot sizes, the National Stock Exchange has not acted to change the lot sizes, resulting in the unhappy situation of my not being able to take on a Tata Motors contract because it violates my position size limits. (Tata Motors is at 797, and the lot size is 850, a contract size of 6.7 lakhs, which is way above comparable F&O contracts which are 2-3 lakhs each)

Luckily, the NSE has now decided to bite the bullet and changed contract sizes to bring them in line with the SEBI notification. For the following stocks, lot size downgrades happen on April 30 (after the current contract expires):

As you can see, the contract sizes are divisible so if you own a May contract today, you’ll own two (or three in some cases) contracts on May 30.

In a wider move, 111 contracts are being changed where there is no divisibility; for example Tata Motors’ Lot size changes to 500 instead. Some 59 others are being revised upwards, to reflect a fall in the stock price. For example, Bajaj Hindustan goes from 1425 to 2000 (the stock’s at 136).

These changes will only be on contracts starting July 2010. April, May and June contracts will continue to have the current sizes.

Index contracts have changed too. Bank Nifty goes from 50 to 25, CNX IT goes from 100 to 50 and Nifty Midcap 50 goes from 300 to 75.

This is good news for F&O traders.

SEBI has now specified new lot size standards for all futures/options contracts:

Example: The lot size for an underlying with a price of Rs. 250, i.e., in the
price band of Rs. 201-400, will be 1000 shares.

This will differ dramatically from the current system – where lot sizes are anything that NSE seems to want. SBI’s current lot size is 132, RELINFRA is 276 and HINDALCO 3518. The new system will keep all lot sizes close to something we can remember.

So how did these odd lot sizes come into play? When a company splits, gives bonuses or has a rights issue or demerger, the lot sizes of its shares' futures contracts are split accordingly. If a stock with a lot size of 100 and price of Rs. 1000 has a 40% rights issue at a certain price, the stock on the post-issue date will reduce by a certain price (to accommodate the new shares available) – if that reduces the price to, say, Rs. 750, the lot size needs to go up to Rs. 133.33 just to reflect that fact – usually that’s why these odd lot sizes come into play and remain there.

So if lot sizes need to be changed, they will happen only in further contracts. Currently contracts till March are traded, so expect changes in the April contract onwards.

The SEBI circular says the new-contract rule will only apply if the lot size is “higher” than the old one. That is after this change goes through the first time. So if I hold one future lot (1000) of a share that was Rs. 300 but goes up to Rs. 450, the lot size will become 500 shares and I will then have two lots, so my holding remains the same. This will happen in between expiries too, in a middle of a month (currently lot size changes seem to happen on Expiry days)

This should help with some of the stocks that have had runaway movements and whose contract sizes are over Rs. 10 lakhs, way too expensive to use on a reasonable portfolio.

The change will not apply to index contracts like Nifty.

Note that this is considerably different from the U.S. where the lot size is 100 shares regardless of where the underlying share trades. In India the idea is to maintain a future lot between 2 and 4 lakhs; these are low limits that haven’t changed for the last 8-9 years, and have today made F&O trading a lot more affordable.

19 stocks have had their lot size divided by four, 122 are cut to half and 2 have been rounded off after division. Only one stock, Sterling Biotech, has seen the lot size go up.

The last time this kind of operation was announced was in December 2008, increasing lot sizes for contracts starting March 2009. And now, this will happen only for contracts expiring in September 2009, i.e. new contracts introduced after the June expiry. Lot sizes for the June, July and August expiries do not change.

Why not? Because they've been traded for the last few months - remember that the June contract opened after the March Expiry, i.e. on March 27th. But there's nothing wrong with doing it technically, if you're cutting down lot sizes of course...you just multiply the held lots by the same number you are dividing the lot size. I think the NSE wants to do the same thing both ways - when they increased the lot sizes they *had* to wait three months.

Also the reason why they always choose a multiple is to let calendar arbitrage happen - where I would like to buy one contract and sell another, and thus hedge.

Overall, the idea is good and should help in liquidity and attracting retail participation. It may soon be time to revise contract sizes again, though I don't know which way!

• Mini contracts on equity futures, apart from the Mini Nifty. That happened almost automatically as some stocks fell 90%, but now they may be formalised.
• LEAPs or long term options on stocks and indices. Currently on Nifty only, the recommendation is to do this for stocks and other indices also.
• Futures and Options on the VIX. Useful to hedge option contracts.
• Options on Currency futures. These are unbelievably useful.
• Bond Indices and related F&O. Oh goodness, finally, one can short bonds too. If this is approved.
• Futures on other currencies: Yen, Euro, Pound.
• Strategy based ETFs - like covered calls and puts.
• Credit derivatives, exchange traded or settled.

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