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The Indian capital market has witness impressive growth and qualitative changes,
especially over the last two decades. In the fifties, sixties and most of the seventies, it
was in a dormant stage when the investors were generally not familiar with, or inclined
towards, the corporate securities. During this time, only few companies accessed the
capital market. As a consequence, trading volumes were low during these years. The
process of liberalization of the Indian economy since the early nineties has contributed
to changes in the capital market scenario. The entry of foreign investors in the
market has resulted in a substantial change in the scale of operations. Now, we are on
the threshold of introduction of trading in derivatives including futures and options,
which is expected to bring a qualitative change in the capital market.
In this chapter we will discuss about the introduction of future and options trading on
the Indian Bourses. However, we will first consider analytically the Badla System
which has been an integral part of the Indian markets for long and how does it compare
with the futures and options. Along with it, a review is made of the form in which an
option trading has been prevalent in the Indian capital market.
The Badla System
The system of forward trading was prevalent in the Indian capital market for decades. It
originated as fortnightly clearings, the clearings being meant as ‘contract for
clearance and settlement through clearing house’, under the bye-laws and
regulations of the stock exchanges. Such contracts for ‘clearing’ were prohibited
in June 1969 by the government of India vide a notification under section 16(1) of the
Securities Contract (Regulation) act 1956.This led to a reduction in thestock
market activities.
A forward trading system was introduced by the government of India in July, 1983 in
the Bombay, Calcutta, Delhi and Ahmedabad stock exchanges. Under the system, the
listed shares were divided into two categories: specified and non-specified. The system
permitted the carry- forward, or badla trading in specified shares. The underlying
principle of the system was simply this that although, strictly, forward trading could not
be undertaken, transactions were done on a spot basis, but the settlement was carried
forward.
The system was stuffed with a strict schedule of regulatory measures like daily margins,
carry over margins, automatic margins, limits on holdings of individuals, limits
on price fluctuations- daily and fortnightly, etc. the system induced liquidity in the stock
market, which was largely due to participation of the retail investors who otherwise had
no access to fund the purchases. The badla system of trading worked well and led to a
stupendous growth of the market in terms of various parameters like the number of
investors, number of new issues, market capitalization and turnover.
In 1991, the Ministry of Fi9nanace asked the Society for Capital Market Research and
Development to undertake an expert study of the trading in shares in stock exchanges,
one of the terms of reference to look into the working of Badla system inshares and its
effect on trading. In terms of the finding of the study, it was observed that, typically
only about one-fourth of the outstanding position at the end of settlement got settled by
actual delivery, while the remaining bulk got carried forward to next settlement. The
committee did not seem to be in agreement with the brokers’ defence of the system
as a provider of liquidity. If felt the carry forward system to be totally unjustifiable and
unhealthy practice in economic terms. The system of Badla helps neither speculators,
who have neither money to pay nor shares to deliver. In its view, the liquidity provided
by speculators, who are not interested in paying and taking delivery on the settlement
date, can not be considered as a genuine liquidity. Accordingly, it recommended doing
away with the carry forward system.
The Badla system was banned in December 1993 by the market regulator, SEBI,
presumably because it led to excessive speculation and/or its misuse. Based on the
recommendations of the G S Patel committee that the SEBI had set up, a new carry
forward trading system was introduced in January 1996. However, the system did not
fond much favour with the broking and investing community. The revised carry forward
system entails a number of restrictions which have made it unattractive.
Limits on the Carry Forward Transactions
Margins
Limited Carry Forward
Cumbersome Reporting Requirement
There were voices for relaxations in the stringent conditions laid down in the revised
carry forward scheme from time to time and even demands for reviving the old badla
system. The re-introduction of Badla trading was suggested in some quarters to be key
to the revival of the capital market on account of their deep faith in the ingenuity of the
system which simultaneously facilitates hare financing, share lending and carry
forward.
Badla: Operation and Rationale
We may look the modus operandi of badla, which has been prevalent I the
Indian markets. Under the bye-laws of the stock exchanges, a contract in
specified shares can be for
1. Spot delivery
2. For hand delivery
3. For special delivery
4. For the settlement
Unless otherwise stipulated, when entering into the contract, a contract is deemed to be
for the current settlement.
At the end of a settlement, all the transactions for each broker are clubbed together and
each broker’s net position is worked out for that settlement. The brokers then
decides in consultation with his clients whether they would accept/give delivery of
the shares and pay/receive money in full for the same, would carry forward the
sale/purchase. Thus, outstanding positions at the end of a settlement may be categorized
as the seller, who want, and those who do not want, to give deliveries, and the buyers
who want, and those who want do not want, to take deliveries.
Now the buyer does not want to take the delivery and desires to carry forward the
transactions from the current settlement to next settlement period, he usually has to pay
contango charge or the badla to the seller. It is a consideration for acquiring by the
rights of the rights and the obligation in the shares. If some of the buyers do not want to
take delivery in case the quantum of delivery sales exceeds the quantum of delivery
purchase, the financiers know as uyaj badla wale emerge, who take the delivery in the
current settlement fro the seller giving the delivery and give the delivery I the next
settlement to the buyers carrying forward the transactions, receiving the difference
between the settlement rate and the sale rates for the next settlement as interest charges.
This is termed as seedha badla and the transaction is known as uyaj badla or Mandi
badla
The badla charges for carrying forward the transaction are determined by the inter-play
of the market forces in a half-hour session at the end of the current settlement period
and at the beginning of next settlement, know as Badla session. Theses charges, which
vary in the half-hour badla session between scrips and also for the same scrip, depend
upon various factors like prevailing interest rates, technical position of the market, etc.
The rationale for providing the badla facility to carry forward transactions from one
settlement period of two weeks to another is that it imparts liquidity and breadth to the
market. This allows the absorption of large purchases and sales in relatively narrow
fluctuations in prices, leading to stability in the market. The carry forward system
provided the investor an opportunity to enhance his position significantly towards
liquidity, forecasting of the future market behaviour and reasonable level of speculation,
which are essential ingredients for an efficient functioning of the secondary
capital market.
In the absence of such a facility, all purchases would be required to be taken delivery of
with the payments being in respect of the same and, similarly all sales outstanding at the
end of the settlement have to result in delivery with respect to the consideration amount.
Such a situation would lead to an ill-liquid and narrow market characterized by sharp
oscillation in prices. This is reflected in the fact hat the movement of prices in the
specified group is relatively more orderly than in case of the non-specified shares.
Badla versus futures and options
From our discussion about Badla, and the futures and options, it may be observed that;
1. In badla, all net position at the end of the settlement period can be carried forward
and members pay or receive badla charges, while in futures and options, various
combinations are available which in futures and options, various combinations are
available which enable the operators to close or recluse the open position till the
maturity period, and carry forward of open position to the next maturity period is
neither necessary nor possible.
2. Badla is basically a financial mechanism. Badla financiers provide finance to the
members with net bought positions. On the other hand, no such financing
mechanism exists in futures and options.
3. Badla system encourages short sellers as they generally get badla charges.
However, both bulls and bears have an opportunity to trade in case of options and
futures.