Futures on individual stocks were introduced at KSE in July 2001. They have shown a healthy growth since then. Their average daily traded value has risen from less than half a billion rupees to more than Rs 2 billion. Currently, they are averaging about 30 per cent of the traded value in the Ready Market.

While this performance in just a year and a quarter is impressive, Futures are still performing well below their potential. This is supported by the trend in the international markets, where turnover in Derivatives equals or exceeds the turnover in the ready market.

Index-Futures account for large trading volumes in the derivatives segment across the world.

* S&P 500 Index is the most popular Futures index in the world with an average monthly turnover of $1100 billion . S&P 500 constitutes about 70 per cent of the total turnover at NYSE and NASDAQ.

* At Eurex, Europe’s leading derivatives exchange, monthly turnover of Index-Futures is about $500 billion.

* Average monthly futures turnover at National Stock Exchange, India, is $4 billion with 80 per cent turnover in Stock-Futures. Indian derivatives market is one of the few markets in the world in which index futures have been dominated by stock futures.

Here we wish to look into the desirability and feasibility of introducing Index-Futures at KSE.

Benefits for the investors: Index Futures shall offer a number of benefits to the investors.

i. Index-Futures provide a unique opportunity to take a position on a broad equity portfolio without buying or selling a single stock.

ii. Index Futures are well suited for risk takers who wish to do leveraged speculation. Leverage, however, cuts both ways and both losses and profits are magnified.

iii. Index-Futures are well suited for those who wish to reduce risk by shifting it to others. These shall provide hedgers a better opportunity than stock-Futures for a quick and broad-based hedging within the liquid stocks.

iv. Index-Futures provide an equal opportunity to both the bulls and bears to profit from their expectation. Unlike restrictions on short or blank selling in the Ready market, there are no restrictions on taking a sale position in an index.

v. Index-Futures are well suited to margin financing because no principal payments are involved and positions can be monitored easily.

Benefits for KSE: Index Futures shall also offer a number of benefits to the Karachi Stock Exchange.

i. There would be lesser settlement risk because there would be no settlement by delivery and therefore no principal payment. At the expiry of contracts only profits and losses shall be settled.

ii. Room for manipulation in Index-Futures is less than that in individual stock-Futures. It is more difficult to move an Index than it is to move the price of an individual stock.

iii. Due to lack of delivery, processing costs would be lower and CDC charges shall also not be applicable. This operational and financial convenience is likely to encourage brokers and investors in speculating in Index-Futures.

iv. Index-Futures would boost the Futures market in which growth by adding number of scrips has become difficult. Suitability for stock-Futures trading requires the underlying stock to have large capitalization, significant free float, good fundamentals, better disclosure and governance practices, and most importantly ample liquidity. The stocks that could broadly fit this description already have stock-Futures.

v. Being a new product, Index-Futures are likely to expand the market and increase the revenues for the exchange. Having Index Futures would also improve the image of KSE as a modern and developed exchange.

Key success factors: Success of Index-Futures requires the following:

* Construction of a suitable index is the first step towards Index-Futures. Currently, the most popular index in the country is KSE-100. This is not suitable for index trading because it has a large number of illiquid stocks and most of the index weight is highly concentrated.

* Index-Futures should not be subject to discriminatory margins. They should be able to compete with Stock Futures and Carry Over Market on an equal footing.

* Market should have a large number of speculators and hedgers. There is no dearth of speculators in our market. Hedging however is done more by institutions rather than individuals. With the increasing institutional presence in the capital market, the number of large hedgers would also increase.

* Contract sizes should be such that they cater for both retail and institutional clients. If the contract size is kept too large, it’d deter the smaller speculators, and if too small, it’d create hassle for the institutions.

Comparison of Index Futures, Stock Futures, & Badla at KSE Index Futures Stock Futures Badla Purpose is speculation, hedging and arbitrage on a large portfolio Purpose is speculation, hedging and arbitrage within individual stocks Purpose is speculation for financees and interest income for financiers Low settlement risk for the exchange as only differences (profits/losses) are paid and no principal payments are involved Medium settlement risk because settlement can be done through delivery and open interest accumulates for settlement at the expiry of the contract High risk for the exchange as overtrading is encouraged and there is the possibility of withdrawal of financing from the market Less room for manipulation as underlying portfolio is wide and deep More room for manipulation than index futures because underlying asset is a single stock more room for manipulation than both Index-Futures & Stock Futures Investors can go both long & short Investors can go both long & short Investors can only carry over a long position Low impact on liquidity in the Ready market Low impact on liquidity in the Ready market High impact on liquidity in the Ready market To be determined by market forces ranging from one month to three months One month contracts Indefinite expiration; minimum of 10 days at the option of the Financee Income for investors by Capital gains only Income for investors by Capital gains only For the speculator income is by capital gains and dividends; for the financier interest income only.