As a result, of the top 15 stocks, which account for roughly 40 per cent of the F&O turnover, 12 stocks will see a significant reduction in their contract sizes. On an average, the contract size will reduce by Rs 1.78 lakh for 12 companies, while three companies will see an increase by Rs 80,000.

The move according to market participants will result in an increase in futures volumes. “The standardisation is simpler as fixed lot sizes have been allotted depending on prices of the underlying security. The participants now have to just remember few lot sizes instead of the prevailing 180 different lot sizes,” says Yogesh Radke, head of quantitative research, Edelweiss Securities. The new system may not have any significance on the large deals carried out by the foreign investors or institutions as they are value driven rather than volume driven, he adds.

Contracting contracts

The new lot size system introduced by SEBI will reduce the lot sizes of 12 out of top 15 traded contracts

Source: Bloomberg. The above table is an illustration of how Sebi’s new guidelines will impact the F&O lot sizes. Note: Average prices are for the period Dec 16, 2009 to Jan 15, 2010.

Uniform lot sizes across the exchanges (BSE as well as NSE) will also see an increase in the arbitrage opportunity. Market neutral strategies, such as pair trades, will also increase as the difference between lot values come down. “Any arbitrageur will be more than happy with this change in lot size system. This will reduce the investment in pair trading and will boost the ROI (return on investment) of the trade,” points out Alok Agarwal, PMS head of KR Choksey Share & Securities.

For example: In a pair trade that involves going short on Axis Bank and long on SBI, the cost currently works out to Rs 3.89 lakh assuming a 25 per cent total margin. Shorting Axis bank would cost Rs 1,20,375 (25 per cent of contract value of Rs 4,81,500, which is the cost of one lot of 450 shares at a price of Rs 1,070) and going long on SBI would cost Rs 70,950 (25 per cent of Rs 2,83,800 based on one lot of 132 shares at a price of Rs 2,150). Besides, one has to purchase additional shares of SBI in the cash market worth Rs 1.97 lakh to make the pair trade market neutral. (A pair strategy involves taking opposite positions of equal value in two stocks. Since the contract value of the two stocks Axis and SBI are not equal, one has to make up for the difference by buying shares of the difference amount in cash market.)

In the new system, however, because of the reduction in the lot size of Axis, the investment for the trade drops to Rs 1.34 lakh (the new lot size for Axis is 250 and SBI 125). Since the contract value or the exposure amount is equal under the new lot size, little or no additional purchases have to be made in the cash market where no leverage is available. In other words, you now get four times leverage on your upfront money committed (25 per cent margin) while earlier a large part of your commitment was going towards a cash position reducing the leverage and in turn the potential returns. Whenever arbitrage activities increase the excess in the market are in check. With the increase in the depth of the stock futures segment even the volatility overall would come down gradually,” adds Agarwal.

However, a section of the market still believes that Sebi can actually rationalise the lot sizes further as what it has done for stocks trading less than Rs 25. These stocks will have lot size in multiples of 1,000. According to participants, taking a step further if this system is implemented across the board with lot size in multiples of 100 shares, then retail participation can go much higher.