Liquidity Products in Stock

Exchanges
Dr. Mohinder Singh
Liquidity in The Market
• Liquid Market : A market is liquid when trade can be done without significant impact or
adverse effect on price
• Immediacy : How quickly a market order of a given size is can be traded at a given cost.

• Depth units available at a given price of liquidity (if there are many order both market or limit, around
the LTP)-Large

• Width or Breadth ( cost per unit of liquidity i.e. The spread between Bid/Ask) Small

• Resiliency : How quickly price restore to reasonable level after they temporary change due to large
order flow imbalance initiated by uninformed traders . Trading by uninformed traders has little effect
on price in resilience market.

• Origin or Supplier of the liquidity : Dealers or Market Makers (immediacy), Block

Dealer, Value traders (informed traders, Depth), arbitrageurs and trader are the

• Source of Liquidity : Natural or Public Buyers and sellers of the stocks

• Limit order supply the liquidity where as market order take the liquidty
01-Liquidity Products: Margin Trading
• Margin: An advance payment of a portion of the value of a stock transaction. The
amount of credit a broker or lender extends to a customer for stock purchase.

• Margin Trading also refers to intraday trading in India, is trading in securities based

on Margin, that is, a client deposits Margin (which is percent in value of the
proposed transactions, and than borrowed funds (to purchase the securities) or
securities needed for sale of securities. This way, a client can buy or sell more
securities than what he would otherwise have been able to with his own resources.

• Margin trading involves buying and selling of securities in one single session.

• In March 2004, SEBI allowed Margin Trading in the cash segment for Group-I
securities (having mean impact cost less than or equal to 1 % and have traded
more than 80% (+/- 5) of the days during last six months
Liquidity Products: Margin Trading ..
• Need to open a margin account with brokers by paying a certain amount of money upfront to
the broker in cash, which is called the minimum margin i.e. 40% (broker use this money to
recover some money by squaring off, in case trader lose the bet and fail to recuperate the
money).
• Once the account is open, you are required to pay an initial margin (50% as IM), which is a
certain percentage of the total traded value pre-determined by the broker before purchase.
• Than , need to maintain the minimum margin (MM) called as Maintenance Margin through
the session is calculated as a percentage of market value of the securities, calculated with
respect to last trading day’s closing price, to be maintained by client with the broker.

• When the balance deposit in the client’s margin account falls below the required
maintenance margin, the broker shall promptly make margin calls or the trade will get
squared off automatically by the broker.
• Curb on short selling or buying, transparency in dealing
Liquidity Products: Margin Trading
• The trader need to square off your position at the end of every trading session Or convert
it into a delivery order after trade, for which case trader has to keep the cash ready to buy
all the shares bought during the session and to pay the broker’s fees and additional
charges.
• Otherwise, the broker will automatically square off the position in the market.
• The brokerage for intraday trading is always lower than that for delivery trading.
• This way you can also short sell the share
• Margin means leverage and the advantage of margin is that if you pick right, you win big.
• The downside of margin is that you can lose more money than you originally invested.
• Buying on margin is definitely not for everybody as extremely risky.
• Margin Available and used Charge Interest on Outstanding amount
• A single client does not exceed 10 per cent of the "total exposure" of the broker.
Liquidity Products: Margin Trading ...
• Corporate brokers with net worth of at least Rs.3 crore are eligible for providing Margin trading
facility to their clients subject to their entering into an agreement to that effect.
• It has also been specified that the client shall not avail the facility from more than one broker at any
time.
• The facility of margin trading is available for Group 1 securities and those securities which are
offered in the initial public offers and meet the conditions for inclusion in the derivatives segment of
the stock exchanges.
• For providing the margin trading facility, a broker may use his own funds or borrow from
scheduled commercial banks or NBFCs regulated by the RBI. A broker is not allowed to borrow
funds from any other source.
•  The "total exposure" of the broker towards the margin trading facility should not exceed the
borrowed funds and 50 per cent of his "net worth".
• Maximum loan by the broker for margin trading shall not be more than 5 times of their Net wroth
02-Liquidity Products: Short Selling

• Short Selling means selling of a stock that the seller does not own at the time of trade.
Allowed in December 20, 2007
• Who: Short selling can be done by retail as well as institutional investors.
• Naked short sale is not permitted in India, all short sales must result in delivery,
• No institutional investor shall be allowed to do day trading

• Securities tradable in Derivative segment (F & O)

• Upfront disclosure (II) and End Disclosure by Retail investors about SS
• The brokers shall be mandated to collect the details on scrip-wise short sell positions,
collate and upload the data in next following day.
• A scheme for Securities Lending and Borrowing (SLB) shall be put in place to provide
the necessary impetus to short sell.
03-Securities Lending & Borrowing (1997)

• Securities’ Lending and Borrowing (‘SLB’) describes the market practice

whereby securities are temporarily transferred by one party (the lender) to
another (the borrower) via an approved intermediary.
• The Borrower is obliged to return them either on demand or at the end of
an agreed term and also has an option to early return. Lender may recall
securities at any time within normal market settlement cycle.
• SLB helps in improving market liquidity, more efficient settlement, tighter
dealer prices and perhaps a reduction in the cost of capital.
• It provides lender incremental return on an idle portfolio and to cover short
position or for Hedging of futures & options positions or to reap benefits of
the market sentiment
04-Securities Lending & Borrowing (1997).

• Securities lending transaction is a temporary loan of securities

between Lender & Borrower.
• Describes the market practice by which, for a fee, securities are
transferred temporarily from one party, the lender, to another, the
borrower.
• Borrower is obliged to return them either on demand or at the end
of any agreed term and also has an option to early return.
• Lender may recall securities at any time within normal market
settlement cycle.
• It promotes market efficiency and liquidity
04-Securities Lending & Borrowing (1997)

• Lender • Borrower

– Insurance Companies • Short sellers, especially long

– Banks term shorts , Cash & derivatives

arbitragers or Market makers or
– HNI’s
Retail
– Mutual Funds
• To cover a short position
– Retail
avoidance of settlement failure
• It provides lender incremental
• Hedging of futures & options
return on an idle portfolio positions
• Borrow and lend to reap benefits
Through Approved Intermediary of the market sentiment
Clearing Houses
05-Securities Lending & Borrowing (1997) :SEBI Norms
• “Securities Lending Scheme, 1997
• Through Clearing Corporation/ Clearing House of stock exchanges having nation-wide
terminals who will be registered as Approved Intermediaries (AIs) under the SLS, 1997.
• Eligible scripts for SLB: All having derivatives contracts, ‘Group I security’, Liquid Index
Exchange Traded Funds (ETFs)
• Margin requirements as per Cash Segment
• Under SLB, securities can be borrowed for a period of 7 days to 30 days
• Only through automated, screen based, order-matching platform
• All categories of investors including retail, institutional etc
• The settlement cycle for SLB transactions shall be on T+1 basis
• no lending/borrowing activity during the periods of corporate action
• SLB transactions shall be 10% of Free floated Capital , 10 % of Member position and 1% of
the market-wide position limits of client
• Income from securities lending is exempt from Capital Gains Tax.
SLB Mechanism
05-BASKET TRADING SYSTEM
• With a view to provide investors the facility of creating Sensex linked portfolios
and also to create a linkage of market prices of the underlying securities of Sensex
in the Cash Segment and Futures on Sensex, the Exchange has provided to the
investors as well its member-brokers, a facility of Basket Trading System on BOLT.
• are able to buy/sell all 30 scrips of Sensex in one go in the proportion of their
respective weights in the Sensex.

• Can create own basket with a minimum value of 50,000/- for each order.
• Need to indicate number of Sensex basket(s) to be bought or sold, where the
value of one Sensex basket is arrived at by the system by multiplying 50 to
prevailing Sensex. Example: if the Sensex is 19,000, then value of one basket of
Sensex would be 19,000 x 50 = i.e., 9, 50,000.
06-Liquidity Products: Market Making

• Market making is a process where the market makers offers a two way
quote (both buy and sell) to increase the supply and demand of the scrip.
This increase the liquidity in the stock.
• A market-maker usually is responsible for enhancing activity in a few
chosen securities. In the process, the market-maker provides both a buy
and a sell quote for his chosen securities. He profits from the spread
between buy and sell quotes.
• For example, if the market-maker gives a bid-ask quote of ` 505-500
(which means the market-maker will buy from the market at ` 500 and sell
at ` 505), then the profit is ` 5. For illiquid securities, the profit spreads are
usually higher (within a regulator-prescribed band) because of the higher
risk taken by the market-maker.
06-Liquidity Products: Market Making
• SBTS is beneficial for actively-traded stocks, but not for lesser-traded ones.
Investors usually ignore thinly-traded stocks despite good fundamentals due to
fears that they might not be able to trade more frequently in them.
• Market making is a process where the market makers offers a two way quote
(both buy and sell) to increase the supply and demand of the scrip. This increase
the liquidity in the stock.

• Aimed at infusing liquidity in securities that are not frequently traded on stock
exchanges.
• Market-makers are obligated to buy or sell the security at a price and size they
have quoted
• MM make profits from the spread between buy and sell quotes.
DIRECT MARKET ACCESS (DMA)

• Direct Market Access (DMA) is a facility which allows brokers to offer

clients direct access to the exchange trading system through the broker’s
infrastructure without manual intervention by the broker.
• It provide
– direct control of clients over orders,
– faster execution,
– reduced risk of errors associated with manual order entry,
– greater transparency,
– increased liquidity,
– lower impact costs for large orders,
– better audit trails and
– better use of hedging and arbitrage opportunities through the use of decision
support tools / algorithms for trading.
Auction
• The Exchange purchases the requisite quantity in the Auction Market and gives them to the
buying trading member. The shortages are met through auction process and the difference
in price indicated in contract note and price received through auction is paid by member to
the Exchange, which is then liable to be recovered from the client.
• If the shares could not be bought in the auction i.e. if shares are not offered for sale in the
auction, the transactions are closed out
• “the close out Price will be the highest price recorded in that scrip on the exchange in the
settlement in which the concerned contract was entered into and up to the date of
auction/close out OR 20% above the official closing price on the exchange on the day on
which auction offers are called for (and in the event of there being no such closing price on
that day, then the official closing price on the immediately preceding trading day on which
there was an official closing price), whichever is higher .
Stock Split

To infuse liquidity and to make shares affordable for various investors who
could not buy the shares of that company before due to high prices, a
company split a stock, to increase the number of shares but the market cap
remains the same and price per share goes down.

Provides a signal to the market that the company's share price has been
increasing and people assume this growth will continue in the future, and
again, lift demand and prices.

Another version of a stock split is the reverse split used by companies with
low share prices that would like to increase these prices to either gain more
respectability in the market or to prevent the company from being delisted.
ALGORITHMIC TRADING
• Any order that is generated using automated execution logic shall be known as
algorithmic trading.
• Algo Trading is a noticeable constituent of the Indian share market and occupies
nearly 40% of overall NSE volumes. In other words, Automated Trading or
Algorithmic Trading is a computer trading program that automatically submits
trades to an exchange without any human intervention.

• Algorithmic trading uses computer programs to trade at high speeds and volume
based on a number of preset criteria, such as stock prices and specific market
conditions.
• Automated Algo Trading Platform in India involves Omnesys NEST, Presto ATS,
ODIN, AlgoNomics, MetaTrader.
Book Closure and Record Date
Book closure refers to the time period when a company will not handle
adjustments to the register, or requests to transfer shares. The book
closure date is often used to identify the cut-off date determining which
investors of record will be sent a given dividend payment.
Record Date: Company does not close its register but is the cut off date
for determining the number of registered member who are eligible for
corporate benefits.
Ex-dividend date is the day after which, if you purchase the stock you are
no longer entitled to receive the dividend.

Example: 27th June as book closure date, than Record

Date will 25 and ex dividend date will 26
Book Closure and Record Date...
• The declaration date is the date when the company announces the amount of
dividend. The dividend is paid generally after 20-25 days of the declaration
date, as it takes time in maintaining the record and identifying the
shareholders who are entitled to the same.
• The stock price may reduce by the amount of dividend after the ex-dividend
date, as new investors are no longer entitled to receive the dividend.
• No- Delivery Period Only trading is permitted not delivery and delivery is done
after the ND period
• Short Delivery: For pay out , you have bought 100 shares and get the delivery
of 70 shares. There is a short delivery of 30 shares and exchange will give you
after 4 days by buying in auction market.
DEMUTUALIZATION OF STOCK EXCHANGES
• The process of demutualization is to convert the traditional “not for-profit” stock
exchanges into a “for profit” company and this process is to transform the legal
structure from a mutual form to a business corporation form. SEBI had set up a
committee under the Chairmanship of Justice Kania
• The board of a stock exchange should consist of 75% public interest/
shareholder directors and only 25% broker directors, and
• 51% shareholding of the stock exchange should be divested to public and only
49% of shareholding Trading members
• Broker-owned stock exchanges into professionally-run corporate stock
exchanges
Purpose of demutualisation
• Stock exchanges owned by members tend to work towards the interest of
members alone, which could on occasion be detrimental to rights of other
stakeholders. Division of ownership between members and outsiders can lead to a
balanced approach, remove conflicts of interest, create greater management
accountability.
• Publicly owned stock exchanges can enter into capital market for expansion of
business.

• Publicly owned stock exchange would be more professionally managed than

broker owned.
• Demutualisation enhances the flexibility of management.
Derivatives Trading