Speculators bet big on interest rate futures amid rate cut hopes

MUMBAI: Interest rate futures could not have come at a better time. With rates set to decline, speculators who want to profit disproportionately are building long positions in futures, and many have even exhausted their individual limits in the market.
While high net worth individuals (HNIs) are going long (buying) on the 10year underlying benchmark securities, some institutions including banks and others which are tapping arbitrage opportunities between IRF and the cash market, are seen short-selling in the interest rate derivative market.

“People who have views and a risk appetite, but don’t have the capital, can benefit from the interest rate futures as you can execute your view by just paying the margin money,” said Shashikant Rathi, head, investments and capital markets, Axis Bank.

“IRF volume is likely to rise with the market getting more mature,” he added.

Institutions are seen taking an arbitrage opportunity between cash and IRF mar ket, especially when the underlying bond price is quoting 15-20 paisa higher in IRF.

At the expiry of the current month contract, they sell in the cash market and square off positions in IRF. Else, they roll it over to the next month at a premium.

HNIs are going long (buying) on the 8.40% contract as they expect a series of interest rate cuts and rally in bond market.

The Reserve Bank of India reduced the repo, or policy rate, on January 15 marking the beginning of a benign rate cycle. The benchmark 10-year government bond yield slipped 10-15 basis points to 7.70% in the past few days as priced moved up. The benchmark bond is the main underlying instrument for IRF trading.

Since then, open interest or total outstanding contracts not yet squared off, have spurted to a record high at 3,66,943 contracts compared with about 2.7 lakh contracts earlier, shows data from NSE, which has majority market share among other exchanges.

Increasing open interest along with rising prices suggests higher participation. The average daily volume is now about Rs 3,000 crore on NSE compared with about Rs 2,000 crore a few months ago.

NSE normally charges 2% or 3% as margin money. This means, for every Rs 100-crore investment exposure, an investor has to pay only Rs 2 or 3 crore to book an IRF contract. If he incurs a loss, he has to fork out only the loss amount, not the entire sum. On the BSE, too, open interest shot up to 82,149 contracts from 54,949 between January 1 and 27.

“IRFs are now in the right form with cash settlement as one of the key features which was not there earlier,” said Nirav Dalal, group president & senior managing director, financial markets at Yes Bank.

“Some regulatory enablement in terms of insurance participation will help increase volumes further as insurers would also be interested in using the platform to hedge their existing holdings.” IRFs are no different from stock and currency futures on which individual traders and institutions have honed their skills. In IRF contracts, a trader will go long when he expects the price of the 10-year underlying bond to rise.