Physical stocks disclosure

Open interest tells you how many contracts are still alive. It does not tell you whether the goods exist.

So exchanges publish the warehouse figures too. Physical stocks — stocks in warehouses — give an indication of the extent to which open interest is supported by the physical stocks.

Read the two numbers together and you learn something neither gives you alone.

If warehouse stocks are low against open interest, the workbook's reading is that the open interest has a higher possibility of getting squared off soon, before the contract expiry nears. There is simply not enough goods for all of it to go to delivery.

That matters to different people for different reasons.

A trader reads it as a hint about what the last week of the contract will look like. A hedger who actually wants the goods reads it as a warning about availability.

And the exchange reads it as a risk signal. A jump in open interest not backed by warehouse stock is one of the triggers for extra margin.

As a disclosure. Physical stocks is one of the items exchanges disclose on their websites and terminals. The workbook's own gloss: stocks in warehouses give an indication of the extent to which open interest is supported by the physical stocks, and if stock in warehouses is less, it may indicate that open interest has the higher possibility of getting squared off soon before the contract expiry nears.

Its siblings in the same list, which are meant to be read alongside it:

So physical stocks say what could be delivered; delivery details and delivery intentions say what is being delivered.

As a margin trigger, which is where it bites. Additional and special margins are imposed to prevent overheating in the market and to ensure market integrity. The workbook names four indicators for deciding them:

1. a one-sided run in the futures prices, upward or downward;
2. a growing divergence of futures and spot prices;
3. a significant increase in open interest not backed by stocks in warehouse, particularly in the near month contract; and
4. client-level concentration of open interest on the buy side or sell side.

Additional margin is levied on both sides — buy and sell — and its purpose is mainly to reduce the market's overheating in terms of higher open interest. Special margin is levied on only one side of the open interest standing in the market, to correct open interest and price momentum on the side that seems to be affecting market integrity. And existing guidelines require the exchange to take the regulator's view before levying or revising any kind of additional or special margin.

No ratio is prescribed. The workbook gives no coverage ratio, threshold or tolerance at which low warehouse stock triggers anything. The phrase is left qualitative — if stock in warehouses are less — and the margin decision needs the regulator's view rather than a formula.

Tejaswi Agro follows the near-month chana contract, lot size 10 MT, and watches the two disclosures together.

On 26 November only 12.8% of the open interest could be delivered from the reported warehouse stock. So the great bulk of it has to be squared off before the tender period — which is precisely the inference the workbook draws from low warehouse stocks.

Now the exchange's view of the same two rows. Open interest rose by 400 lots, or 4,000 MT, while warehouse stock fell by 9,000 MT. That is a significant increase in open interest not backed by stocks in warehouse, in the near month contract — indicator number three on the margin list.

Suppose the exchange also sees a one-sided run on the buy side. Having taken the regulator's view, it imposes a special margin on the buy side only. At a chana price of Rs 5,500 per quintal, a 10 MT lot is 100 quintals:

Contract value per lot = 100 x 5,500 = Rs 5,50,000

At an illustrative special margin of 5%, that is Rs 27,500 per lot. A client holding 40 lots long gets a call for Rs 11,00,000 of extra margin overnight.

And there is the loop. The very margin that the thin warehouse stock helped trigger is itself a reason to square off — which is how the disclosure's prediction tends to come true.

Had the exchange instead simply wanted to cool the total open interest rather than punish one side, it would have used an additional margin, levied on buy and sell alike.

Chapter 6 (Trading Mechanism), section 6.9 on disclosures by exchanges, where physical stocks appears in the list with its own one-line interpretation, and Chapter 7 (Clearing, Settlement and Risk Management), section 7.11.4, where open interest not backed by warehouse stocks appears as an indicator for additional and special margin.

Expect a reasoning question: what does a low level of stock in warehouses indicate — that open interest has a higher possibility of getting squared off before the contract expiry nears. And expect the four-item margin indicator list, where this is the third, usually paired with the additional-versus-special margin distinction.

• The workbook's inference is squaring off, not a delivery squeeze. Low warehouse stock indicates open interest is more likely to be squared off before expiry nears. Do not upgrade that to a price prediction.
• It is a disclosure, not a limit. No ratio of warehouse stock to open interest is prescribed in this paper, and the phrase is deliberately qualitative.
• Physical stocks is not the same item as details of deliveries or summary of delivery intentions. Stocks say what could be delivered; the other two say what is being delivered.
• The margin trigger is worded narrowly — a significant increase in open interest not backed by stocks in warehouse, particularly in the near month contract. All three qualifiers matter.
• Additional margin is both sides; special margin is one side only. Reading thin warehouse stock as a reason for a one-sided margin is only half the answer.
• No margin follows automatically. Exchanges must take the regulator's view before levying or revising any additional or special margin.
• Warehouse stock is not national availability. It is the stock in the warehouses the exchange reports on, held against warehouse receipts and eNWRs, and it is a far smaller number than the country's supply.