Stock lending booms as reverse arbitrage opportunities surge

After a prolonged hiatus, stock lending has been booming in the last three months due to reverse arbitrage opportunities thrown up by equities.

Average monthly traded quantity in the securities lending & borrowing scheme, promoted by the National Stock Exchange (NSE), has rocketed four-fold from 20 lakh shares in the first eight months of the year to over 80 lakh in the last three.

Experts said this is due to increasingly large number of reverse arbitrage opportunities.

Reverse arbitrage involves selling a stock in the cash segment and simultaneously buying it in futures to benefit from the price difference.

Stock lending facilitates this as investors can borrow the shares and tend them in cash segment while simultaneously creating a buy position in the futures segment.

The second leg of this transaction involves closing the positions later by reversing transactions.

“Lately, there have been clear opportunities to engage in reverse cash and carry arbitrage, which has led to many of the domestic high networth clients taking positions in the segment. There are a few large-cap companies where the spread is quite large between cash and futures in terms of prices,” said Karun Mutha, head of derivatives at HSBC Invest Securities.

Shares such as those of the State Bank of India (SBI), Punjab National Bank, Mundra Port and LIC Housing Finance are among the large caps trading at a considerable premium in the cash market compared with their one-month forward prices. The maximum open positions are in SBI where the differential is close to Rs14.

The stock lending mechanism basically involves borrowing the share from others for a specified period of time through approved intermediaries such as the clearing corporations of stock exchanges, primarily to short them in cash.

The lenders, on the other hand, are mainly long-term investors, get lending fees in return without losing on the benefits associated with owning the shares such as dividends or splits or bonus. Currently, regulations allow retail or institutional investors to borrow or lend the shares listed in futures and options segment for a maximum tenure of 12 months.

Another reason for the rising volumes, experts said, is that there is no transaction cost apart from margin money and lending fees.
“The buyers are usually institutional clients such as domestic proprietary desks which want to capitalise on arbitrage opportunities while the long-term investors act as lenders. The segment currently does not attract any STT charges, which is an added incentive,” said Yogesh Radke, head of derivatives at Edelweiss Securities.

Last month, the segment on the NSE witnessed a total of 87.63 lakh shares traded through 1,671 transactions — a huge jump from monthly average of 300 seen for most of this year.
Going forward, experts see wider participation if some rules are altered.

“Though participation from institutional investors to lend is currently on lower side, it will be a big market in future,” said Radke.

Siddarth Bhamre, head of derivatives at Angel Broking, however, feels that there needs to be some incentivisation to attract more institutional investors.

“Also, for stock lending to be successful, we need active physical settlement market in derivatives segment,” he said.