Derivatives market may soon move to physical settlement

introducing physical settlement with trades in stock options. In physical settlement, futures and options trades are settled with delivery of shares, a system, which many believe would prevent excess speculative bets on the markets. The committee, headed by former ISB dean M Rammohan Rao, has recommended that the physical settlement system be the choice of the buyer and be extended to stock futures, after testing it in stock options for six months. “While analysing this experience, parameters such as extent of convergence; ability to handle short-squeeze situations; etc, need to be considered,” the committee report released on Friday said. The committee also acknowledges that a robust stock lending and borrowing (SLB) mechanism is needed for an effective physical settlement system. Committee member Chitra Ramakrishna, deputy managing director of NSE, who voted for introducing this settlement in stock options first, opined: “The lending and borrowing mechanism should be liquid enough so that borrowers have the confidence that they will be adequately meet physical settlement obligations.” The existing exchange-driven SLB system has hardly found any takers, as the current mechanism is considered unviable by most market participants. A section of the brokers said the introduction of physical settlement was not needed or desirable at this juncture, as the system would hike trading costs due to stock borrowing expenses. An institutional derivatives dealer said if the logic of introducing physical settlement is to control manipulation, then this may not be the best step. “Exchanges already have enough tools to control manipulation..it needs to be realised that this situation cannot be avoided in stray cases,” he said.