With the advent of discount brokers in the Indian market, a whole set of trading strategies has opened up for retail investors. But before talking about these strategies, we need to distinguish between a discount broker and a full-service broker.
Unlike a full-service broker, a discount broker does not give advice on what and when to buy or sell. All he offers is a platform to trade, typically online, where the client is expected to punch his own trades. The client has to use his/her own trading or investing skills to make a decision on what to trade.
Discount brokerages like Zerodha, Tradesmartonline, Action Financial, RKSV and Tradejini, among others, have already started hurting the broking industry. Full-service brokers had made a request to market regulator Securities and Exchange Board of India (SEBI) to impose a minimum slab on the brokerage being charged by discount brokers. This request was declined, clearing the way for more aggressive competition.
For those who know what they are doing in the markets, a discount brokerage opens a whole new avenue of money making opportunities. Brokers used to do arbitrage trades and complex price-neutral option trading strategies which involved frequent trading, in their proprietary books. Since a broker is allowed to charge zero brokerage in his proprietary book, these trades which are squared off with minimum profit were feasible. However, for a client these trades were not attractive as the cost of trading them would eat away most of the profit.
Now, the low cost of trading opens up numerous high frequency trading strategies. Among the strategies that are now possible with discount brokerages are arbitrage trades between cash and futures of a particular stock. Futures generally trade at a premium to the stock price, and the difference between the two keeps on changing in a very small proportion during the day, but over the period of the month it narrows.
By buying in cash and selling the equivalent amount in futures, a trader is creating a price-neutral strategy. This means that if the price of the stock and future moves higher he would not be affected as the loss in his futures position would be compensated by the profit in his cash market position. Similarly if the price goes lower, his loss in cash is made up by the short position he has created in futures. The opportunity for the trader is to enter a position during the volatile period when the gap between the two is big and square off as the market cools and the gap narrows.
A similar kind of arbitrage is also possible between two futures (calendar spreads) of different expiries. Since discount brokers are offering a flat brokerage charge per trade this strategy would be profitable even on an intra-day level.
Similarly, the BTST (buy-today-sell-tomorrow) strategy or STBT (sell-today-buy-tomorrow) would be profitable. It is generally seen that if a stock closes near the high of the day then next day it generally opens at a higher level. Similarly if the close is near the low of the day, the next day the stock normally opens lower.
Buying at the closing and selling at the opening the next day in a BTST strategy in a full-service broking house would attract full delivery brokerage which would eat into a major portion of the profit. In a discount broking house, the low brokerage leaves lot more on the table for the client to take home though delivery brokerages are still applicable to him/her.
Option strategies which involve use of multiple options as in the case of a spread or a butterfly strategy would be more profitable with a discount broker rather than a full service broker. There are hundreds of other strategies which require frequent trading. Also, algorithm trading has narrowed the profit making ability of a trader who relied on buying and selling spreads. Under these circumstances low brokerage offers the best chance for a trader who trades on an intraday basis or trades very frequently.
Essential to success in high volume trading is low cost, which for a retail client is offered by a discount trader. He is probably getting a better deal than some of the high net worth clients in a full service brokering house. But then he does not get the inputs from a broker.