by Santosh Nair
The bear market of 2008 brought the high-flying promoters of many mid-cap companies down to earth, or down on their knees, as would be the more apt phrase in many cases. When the market was booming, these promoters had resorted to all kinds of tricks to ensure that their companies made it to the list of securities eligible for futures and options trading. To make the cut, the stocks had to have a minimum market capitalization, and specified minimum daily volumes for a specified period. The promoters would rope in a bull operator, and together they would ensure the stock fulfilled the criteria to make it to the F&O list. For many promoters, their stock being in the F&O list helped them manipulate prices and make a killing from time to time. These promoters used to throw grand parties on the day the inclusion of their companies in the haloed list was announced. I had myself been to at least half a dozen such parties.
Typically, the promoters, in collusion with a market operator, would corner a sizeable quantity of the company’s shares, pushing up the stock price. As the stock price climbed, so would the futures price. Many traders would short-sell the futures, betting that the rise in stock price was not sustainable. But since most of the shares had already been hoarded, the stock price would stay firm, and so would the futures prices. For good effect, the operator would buy some more shares closer to the settlement day of the derivatives contracts, further driving up the futures prices. Eventually, the traders who had short-sold the futures would have to cover up their positions, and this would further drive up the futures price and further increase their losses. Some of the traders with deep pockets would carry forward their short positions to the next settlement cycle, hoping that prices would move in their favour. But so long as the promoter-operator duo controlled the floating stock, short-sellers stood little chance of winning.
In a bear market, however, the presence of these stocks on the F&O list made it easier for bears to hammer their price. The short-sellers would target companies whose promoters they knew were facing liquidity problems. The bears would then get down to short-selling the futures in a big way. Once the futures prices started to buckle under the onslaught of the relentless selling, the spot price too would move down in tandem. The difference this time was that the promoters did not have the cash to prop up the stock price. More often than not, the promoters would have raised money by pledging shares, either from the stock they officially held, or from the stock held in benami accounts. Once the stock price came under pressure, margin calls from the lenders would follow. If promoters were unable to deposit additional collateral, the lenders would start dumping the shares, aggravating the slide in the stock price. The bears successfully deployed this tactic in many mid-cap stocks, and in a reversal of roles, they were the ones laughing all the way to the bank while the hapless promoters licked their wounds.
Not surprisingly then, companies wrote to the stock exchanges begging that their stocks be excluded from the F&O list. Even otherwise, many companies automatically found themselves out of the list once their market capitalization and trading volumes fell below a certain threshold.
During the bull run, many promoters had tried to increase their shareholding cheaply by issuing equity warrants to themselves at a predetermined price. The promoters had only to pay 10 per cent upfront; the rest they could pay at the time of conversion of the warrants to shares eighteen months later. Since the market was in an uptrend, the promoters were confident that they would be able to convert their warrants at a discounted market price eighteen months later.
But the share prices of many of these companies fell so sharply that by the time the warrants came up for conversion, the conversion price was way above the market price. It made no sense for the promoters to convert their warrants, and they allowed them to lapse, forfeiting the 10 per cent upfront payment. A year later, SEBI would hike the upfront payment for equity warrants to 25 per cent so that promoters did not try to short-change minority shareholders.
32
Making it to the Big League
Thanks to my unusually long winning streak for the last couple of years, people in corporate circles began to hear my name. By that, I mean executives on the treasury side, such as chief financial officers. I found some of the fund managers too becoming more approachable now. Thankfully, since most of my gains came from my trading bets and not investment bets (which could be easily tracked from publicly available data), I was unknown to the media. I was perfectly fine with that since I had no desire to be known beyond my professional circles. I slowly began to get invites to parties of the rich and famous, which I refused without a second thought. Promoters began to send feelers to me to help boost their share price in return for a cut. At times, there would be offers to hammer a rival company’s shares. I had been approached in the past too with such requests, but the pedigree of companies that were now seeking my services was a few notches higher.
I have helped quite a few promoters to ramp up their stock prices, but as a rule I never invest in their shares. I have to trade in their stock for a certain period when I am managing its price, but my association with the stock ceases once I have fulfilled my commitment to them. It is good if promoters are mindful of their stock price; that way they may not want to do something rash that will upset the market or their key shareholders. But it is a problem if promoters are obsessed with their stock price. To me it is a clear indication that they are not focusing their time and energy on their main business. And that is a recipe for disaster. Promoters often forget that a healthy share price flows from the strength of their core business and not the other way round. A healthy stock price can at best help a promoter raise money, but he has to put the money to work and show consistent returns to the shareholders. Unless he is able to do that, his stock price will just flounder.
I got to meet some interesting market operators too. JC was the most notable of the lot, and I guess it had partly to do with his flamboyant ways. Anybody who met him once would not forget him easily. His showy ways put off many while amusing others. He had a fondness for expensive watches, and especially loved to tell people what they cost. His manner of speaking could be misinterpreted as offensive, and while that was not always intentional, he had ended up rubbing quite a few names the wrong way with his tactless remarks.
JC had been in the market since the late 1980s, but it was only in the last couple of years that he began to get noticed, for reasons right and wrong. He delighted in short-selling stocks, as though the task of chastening errant promoters had fallen to his lot. He would go long too on stocks, and had a decent-sized investment portfolio, but it was his bearish bets that got talked about and gave him the attention he relished. He won and lost big sums, and from what I gathered, it was his stubbornness that often got him into trouble. He claimed to be a value investor and not one of those operators who colluded with promoters to rig up stock prices. That claim was only partly true because I knew that he had cut deals with some of the dubious mid-cap and small-cap companies to boost their stock prices.
He called me one day and proposed that we meet up. I agreed. He invited me to his office, which I found a bit odd. Somebody else in my position might have taken offence. But I had heard enough about JC’s idiosyncrasies to take umbrage at the suggestion. His calling me over to his office was his way of subtly asserting his seniority over me in the profession and telling me ‘you come and see me’.
I drove down to his office in Andheri, curious to meet the man I had heard so much about. For a man rumoured to be worth a few hundred crore rupees, he had an office that was housed in a nondescript building that was modestly furnished and had barely half a dozen employees.
His cabin was spacious, though not outsized. His arc-shaped, glass-topped table held four trader workstations. Three were placed right in front of JC, while one stood to his right. There was a packet of Davidhoff beside one of the workstations. I glanced at his watch – sure enough, it was an expensive one. A friend of mine who knew JC well had once mentioned that JC’s watch cost Rs 15 lakh.
/> JC claimed to be more of a value investor than a trader in stocks. But most people in the market felt it was the other way round.
‘I prefer companies where the managements don’t try to suck up to you just because they are keen that you buy their shares,’ he said, as we got chatting. ‘Though not a foolproof method, I see overfriendliness as a sign that they crave a higher market value for their shares.’ He said his portfolio comprised mostly blue chips and some well-managed companies that were undervalued at the moment, but held great potential.
‘The blue chips are my nest egg. I never touch them. They are for the future generations. I have ensured that at least six generations of the family can get by without ever having to work. I decide on the maximum loss that I can take on my trading positions and then play within that range. I am like a kid at a video game parlour. I play for as long as the coins in my pocket last. Once the coins are over, I get off the machine.
‘Till 1996, I always used to buy first and then sell. But the bear market showed me that there was good money to be made by doing exactly the opposite too. I began to short-sell at every opportunity, and though a few bets went awry, I made good money. Short-selling is not everybody’s cup of tea, but I find it more challenging. Most of the time I am long on the market. For some reason, it is always my short positions that get talked about.’
‘Of course they would be,’ I said. ‘The aggression with which you go after some of the stocks almost gives the impression that you expect the company to be out of business shortly. I have known some promoters who had trouble getting sleep at night because of your raids.’
JC grinned, and I could see that he seemed pleased with that remark.
‘You exaggerate, Lala, but I try to distinguish between stocks that are overvalued because the market is convinced about their potential, and stocks that are overvalued because the promoters are supporting the stock price. The second category gets its comeuppance sooner than later. One adverse bit of news, or a sudden change in market sentiment for the worse, and these puffed-up stocks collapse like a house of cards. Of course, one has to be patient enough to wait for that break. In the interim, the promoter and operator will push up the stock and you will have to take short-term losses. I have had to suffer quite a few times, but the two or three bets that pay off more than compensated for my losses in other stocks,’ JC said.
JC had warmed to me and was now freely talking about his trades.
I asked him why he had turned bullish on Aban Lloyd (a company that operates oil rigs) after having been bearish on it for a long time. I knew the reason, but I wanted to hear it from him. JC had been bearish on Aban for many months. But he lost a lot of money as the stock price kept rising even as he short-sold Aban futures. Then JC got lucky. The company’s main revenue grosser, an oil rig off the Venezuelan coast, sank. The stock price halved within a week, and JC not only recouped his losses, but made a tidy profit too. Of late, the stock price was on an upswing, and had recovered significantly from the lows of the year even if it was still some way off from its recent highs.
‘Having worked with some of the best market operators, I thought you would have spotted that trick, Lala,’ JC said, once again smiling. ‘The stock has bounced because I have covered most of my short positions,’ he said, looking pleased with himself. ‘Of course, the company is doing poorly. But I am unable to hammer the price down further because all the buyers have fled. I have to attract some buyers before I start hammering down the price once again. To bring them back, I have to create an illusion that the stock price is set to move up,’ he said.
Earlier during the year, I had heard that JC had heavily short-sold the futures of a Mumbai-based realty company. The promoters, in collusion with a bull operator, had pushed up prices and had managed to hold them at a certain level, forcing JC to buy back the futures at nearly three times the price he had sold them for. The talk in market circles was that JC had suffered a loss of Rs 40 crore on that trade. Though it was impolite on my part, I brought the matter up.
‘I heard that trade cost you a packet.’
‘A little, but not as much as the market would like to believe,’ JC said, looking me in the eye. But JC made no bones about the fact that he was mad as hell at the operator who helped the promoter jack up the price.
‘But why make it personal?’ I asked JC. ‘If that operator had declined, the promoter would have enlisted somebody else for that job.’
‘Maybe. But for some reason I took a dislike to that fellow after the incident. Since then I made it a point to short the stocks on which he would be long,’ JC admitted.
‘Now you are contradicting yourself, JC. Just a while ago you said you never allowed ego to interfere with your trading decisions. By hammering some stock just because you want to screw a rival, you risk losing money,’ I pointed out.
He smiled. ‘That is okay. In my position, I can afford an enemy or two. There are plenty of other stocks where you can make money.’
But JC did end up making more than just one or two enemies. According to the market grapevine, he had managed to infuriate the promoters of quite a few companies by hammering their stocks. One of them happened to be a Mumbai-based real estate company with politically well-connected promoters. The promoters first asked him to back off from their stock. JC in turn asked them to get lost. Infuriated by his gall, the promoters sent goons to his office to intimidate him. I even heard that he was roughed up so that he got the message loud and clear. To ask JC about that would be testing his patience. But I know that for some time JC was moving around with a couple of bodyguards in tow. Those who did not know the reason felt it was yet another of his antics to exaggerate his importance.
We chatted for over an hour. As I was leaving, JC came up to my car to see me off. ‘You come across as an intelligent fellow to me. I think we should do business together,’ he said.
I told him it was a good idea, but though we exchanged market views quite a few times after that, we never got down to doing business together.
33
A Level Playing Ground
Some of the policies introduced by SEBI were now beginning to bite. In 2008, it had approved a facility called direct market access (DMA) for institutional investors. Under this system, clients could access the stock exchange’s trading system through their brokers’ infrastructure, but without manual intervention by the brokers. Earlier, a fund manager based out of Singapore or London wanting to trade in Indian shares would have to call the broker in India to place his order. Somebody like me who was thick with dealers at institutional brokerages would often get to know of some of the large-sized orders before they were executed, and front-run them. With the introduction of DMA, global fund managers could route their orders electronically into their broker’s trading systems, and the orders would then find their way into the exchange’s trading engine. The broker would get to know of the orders only after they were executed.
The advent of DMA simultaneously fuelled the growth of algorithmic trading, or programmed trading as it was commonly known in market parlance. In algo trading, a software would execute trades based on pre-assigned commands. At a basic level, the command could be to sell the futures of a stock and simultaneously buy an equivalent quantity in the cash market if the futures were quoting at a particular premium to the spot price. Conversely, it could be to sell spot and buy futures if the futures were quoting at a discount. Complex commands could interlink trading volumes, index levels and a host of other parameters to trigger a trade. DMA and algo trading went hand in hand, as the software would now take over the functions of a dealer. Earlier, if a fund manager placed an order with a dealer at a broking firm for, say, 5 lakh shares within a price range, it would be the dealer’s responsibility to ensure that the order was executed in a way that the price and volume objectives were fulfilled. This meant having to execute the order in separate chunks by gauging the demand-supply situation from the screen, so as not to draw the market’s attention.
&nbs
p; With algo trading, all that would be taken care of by the software. FIIs and foreign brokerages clearly had the edge when it came to algo trading because they could afford to hire the best talent to develop proprietary software. DMA was slow to pick up initially, since the stock exchanges wanted to scrutinize the algorithms before they were allowed to run on their systems. The exchanges had a legitimate concern that algos without adequate safeguards could wreak havoc in the market. Having spent millions on their proprietary trading software, foreign players were reluctant to reveal the secret sauce of their algos. But once the stock exchanges relaxed this rule and the players did not have to reveal the specifics of their algos, DMA took off.
Domestic arbitrage firms, with their huge teams of mercenary day traders, never stood a chance in what was the equivalent of an arms race in the financial markets. For one, humans could never match the speed of programmed machines, which could spot arbitrage opportunities in a fraction of a second and execute them even before a day trader could blink. Local firms did make an attempt to fight back though, through commonly available, off-the-shelf trading software. The trouble with the generic algos was their lack of uniqueness, so that one user firm’s algo trading differed little from another’s. And they were no match for the high-end trading software developed by FIIs and foreign brokerages with their team of highly skilled software engineers.
There was another missing link on the road to superfast trading. Even the best of trading software would not be very effective unless the orders could be executed in the shortest possible time – measured in milliseconds – to beat competing algos. That hurdle was overcome when first NSE, and later BSE, began offering a facility known as ‘co-location’. Under this, brokers could, for a fee, get to place their servers close to the exchange’s trading engine. This would give the broker faster access to the buy-sell quotes streamed from the exchange and also send the executed trades back to the exchange quicker for confirmation. There was a slight lag – in milliseconds, not visible to the human eye – with which the date streamed from the exchange server reached the broker, the lag depending on the distance of the broker’s server from the stock exchange’s trading engine, though it was one of milliseconds. Through the co-location facility, the bigger brokers could race the small brokers in snatching the best quotes.