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CM Strategy

Optionalysis: Lot Sizes Reduced on Oct 31. Prepare To Trade More!

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Futures and Options trade in lots, and these lots are going to change soon. Come October 31, and a number of lot size changes will happen, with most contract sizes decreasing. (The “Contract Size” is the number of shares per lot multiplied by Price per share)

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When you decrease the lot size, the number of shares per lot falls, so you can trade in more granular quantities. SEBI has mandated that lots of futures and options contracts must be such that each contract is around Rs. 200,000 (2 lakh). Some of these lot sizes, set much in the past, saw their size grow past Rs. 400,000 as the share prices have gone up. The revision brings them back to a size of Rs. 200,000 or such.

The really big deal for most F&O traders is that the Nifty contract size has been halved to 25.

A quick look at the contract changes (listed at the end of this post) show that most of the changed contracts were revised downwards.

Contract Sizes

The only one that was revised upwards – United Breweries – has seen the contract size changed from 250 to 500 shares, after its price has fallen to Rs. 700.

55 Contracts: Lot Size Decreased

55 Stocks saw their lot size lowered, including Axis Bank, Cipla, Ranbaxy and HDIL. The smaller lot size means that you can trade these contracts with lower capital (since exposure is lower, and thus, margins are lower).

For smaller portfolios (less than Rs. 50 lakh) such a change is welcome since many contracts had grown so big (along with the increase in value of the underlying stocks) that there was no way to trade them without taking undue amount of risk. Here’s the biggest changes:

Lot Sizes Players

Applicable from October 31: Lot Size Proportionately Decreased

In many stocks, the lot size change has been proportionate. Bharat Forge, for instance, fell from 1000 size to 250 – it’s price had moved up from the 200 levels to the 800 levels. UPL’s lot is down from 2000 to 1000. 

This means that if you own one lot of Bharat Forge of November expiry today, then on Oct 31 (the day after the October Expiry), you will have four contracts of 250 shares each.

Where you could earlier buy just one contract, now you can buy four, and you have the ability to sell one or two contracts instead of just selling the whole thing. (On a graded stop loss, for instance)

If you own a contract (since you can buy some even now), it will be split into four contracts.

Lots REduced

You can buy contracts for November 2014 expiry (or further) and your contract size will automatically be adjusted on Oct 31. From then on, you will have two (or four) contracts instead of one, according to the table above. This won’t change the overall value of the holding, just divided into more lots.  

Two indexes too change size. The Nifty goes from a lot size of 50 to one of 25, which is a huge change because it’s the biggest contract out there. (traded volumes) The Midcap50 index future also reduces in size to half.

(The last time the Nifty Lot size was cut, was in 2007 when it was halved from 100 to 50. )

INdexes

Applicable from Jan 2015: 8 Stocks

Where the lot size change was not a direct multiple or fraction, we have a problem. Look at Ashok Leyland where the contract size has come down from 11,000 shares to 8,000; If we allowed them from Oct 31, then you can buy the November contract (11,000 lot) today till October 30.2013. From then on, if hte lot size becomes 8,000, how can you divide your holding? Because of this problem, such stocks will only see their new contracts visible in the Jan 2015 expiry onwards.

That means the November and December contract for Ashok Leyland will have 11,000 shares, but the Jan 2015 one (tradeable from Oct 31 2014) is a size of 8,000 shares.

Irregular

The Implication

There are good reasons why lot sizes are reduced – to provide an even field for traders. This is a good move, since it brings more contracts into tradeable territory for smaller portfolios. Smaller contract sizes means lower margins per contract (approximately 10% today, so a Rs. 4 lakh contract will involve a payment of Rs. 40,000 as margin) and granular exit opportunities. 

There are still two contracts that are ridiculously overpriced – MRF, with a contract size of Rs. 39 lakh, and Eicher Motors at Rs. 14 lakh. Why aren’t these being reduced? Because the minimum contract size for stocks is 125 shares, and the prices of these stocks are huge (Rs. 31,000 per share and Rs. 11,000 respectively). Regulation hasn’t quite kept pace.

In the past, we have seen mass lowering of stock lot sizes in 2005 and 2009, and before both such times there was a strong upward move. In both cases, volumes in the derivative market only went up after – but it’s too difficult to conclude anything with just two data points. What we at Capital Mind think is that this gives us much more room for derivative strategies.

We highlight all the changes in the (new!) Capital Mind Website: Click here to get to where you can sort/search and see all the changes in a single page.

Note: We have changed the entire layout of Capital Mind, and would love to hear your feedback; please check https://www.capitalmind.in and mail us at premium@capitalmind.in about what you think!

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Disclaimer

Nothing in this newsletter is financial advice and should not be construed as such. Please do not take trading decisions based solely on the matter above; if you do, it is entirely at your own risk without any liability to Capital Mind. This is educational or informational matter only, and is provided as an opinion. 

Disclosure: The authors at Capital Mind have positions in the market and some of them may support or contradict the material given above, or may involve a direction derived from independent analysis.

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