Badla versus futures

B. Venkatesh

SEBI has banned badla trading and proposes to introduce futures in its place.

What is badla trading and how does it compare with futures?

Suppose you buy 1,000 shares of Infosys at Rs 3,500, your cash outflow is Rs 35 lakh. Instead of paying cash, you can ask your broker to find a borrower to finance your trade. This process of buying stocks with borrowed money is badla trading.

The stock exchange acts as an intermediary between you and the actual lender. You will be charged an interest rate for borrowing, which will be determined by the demand for that stock under badla trading. Thus, higher the demand for Infosys under badla trading higher will be the interest rate. You can keep your borrowing unpaid for a maximum of 70 days, after which you will have to repay the badla financier through the exchange.

Those familiar with futures will immediately recognise its similarity with badla trading. Suppose SEBI introduces single-stock futures, you can buy, say, 10 Infosys futures that will at maturity give you 1,000 Infosys shares on payment of money.

You will initially pay a margin and buy 10 futures contract. This is similar to the broker placing a margin on badla trades. The futures contract will be marked-to-market on a daily basis. This means that if you buy Infosys futures today at Rs 3,750 and the price in the futures market goes up to Rs 3,800 the next day, you will have to deposit with your broker Rs 50 (3,800-3,750) times 10 (the number of futures contract).

You will likewise receive money if the futures price goes below Rs 3,750. Of course, in badla trading, it is the broker who has to maintain a marked-to-market margin and not the buyer/seller as in the case of futures.

In essence, however, both futures and badla system allow investors to buy stocks without huge cash outflow. In other words, both help in leveraged trades. It is, perhaps, due to this similarity that SEBI has decided to ban badla and introduce futures in line with the trends in developed countries.