Stock Market of Pakistan | PSX |

   

Stock Market Of Pakistan 

 

Pakistan Stock Exchange (PSX): An Overview

The Pakistan Stock Exchange (PSX) is the largest and most significant stock exchange in Pakistan, playing an essential part in the country’s economy. It enables the trading of different financial instruments such as stocks, bonds, and other securities. It functions as a centralized market where buyers and sellers come together to exchange these instruments.

 

1.          History of the Pakistan Stock Exchange

The beginnings of the PSX can be traced back to the creation of various regional stock exchanges. At first, there were three primary stock exchanges in Pakistan:

·         Karachi Stock Exchange (KSE) – Established in 1947.

·         Lahore Stock Exchange (LSE) – Founded in 1970.

·         Islamabad Stock Exchange (ISE) – Founded in 1989.

In 2016, these three exchanges amalgamated to create the Pakistan Stock Exchange (PSX), establishing a consolidated platform for trading. This merger aimed to enhance efficiency, bolster governance, and offer improved access to capital markets.

 

2.          Structure of the Pakistan Stock Exchange

The PSX is a regulated exchange, which means its activities are supervised by regulatory authorities, ensuring transparency and fairness. The principal regulatory authority is the Securities and Exchange Commission of Pakistan (SECP), which establishes the regulations for market participants and ensures adherence.

The PSX itself is a joint-stock company that functions as a public entity. It is possessed by a range of stakeholders, including brokers, financial institutions, and various private investors.

 

Key Components:

·         Trading Floor: This is the physical space where stocks and other securities are bought and sold.

·         Indices: PSX has multiple indices to gauge market performance. The KSE-100 Index is the most notable, representing the top 100 listed companies in Pakistan based on market capitalization.

·         Brokerage Firms: These are intermediaries that assist in the buying and selling of stocks on behalf of investors.

·         Clearing House: This ensures that trades are completed effectively and securely.

·         Market Makers: These entities add liquidity to the market by offering to buy and sell securities.

 

3.          How the Pakistan Stock Exchange Works

        The operation of the PSX is driven by fundamental principles of supply and demand, similar to         other stock exchanges worldwide. The process commences when a company opts to list its                 shares on the exchange, and investors start trading these shares. 

Below is a summary of how the PSX functions:

     Trading Mechanism

·         Order Types: Investors submit various types of orders, like market orders and limit orders. A market order is completed at the existing market price, while a limit order is initiated to buy or sell at a specified price.

·         Brokerage Firms: Investors often utilize brokers to carry out trades. Brokers are licensed and authorized by the PSX.

·         Electronic Trading: The PSX employs electronic platforms for trading, expediting the process and increasing transparency. This also assists in minimizing the necessity for a physical trading floor.

·         Settlement: After the trade is executed, the transaction is settled by the Central Depository Company (CDC), which guarantees the transfer of securities between the buyer and seller.

 

4.          Types of Business Conducted on the Pakistan Stock                    Exchange

The PSX enables the trading of a variety of financial instruments. Below are the primary types of business activities that take place on the PSX:

4.1.                  Stock Trading

·         Shares of Companies: The predominant type of trading on PSX consists of purchasing and selling shares of publicly traded companies. These businesses can belong to various sectors, including banking, energy, textiles, and technology.

·         Initial Public Offering (IPO): Companies looking to generate capital can offer shares to the public through an IPO. Investors can acquire these shares at a fixed price, and the company receives funding to grow its operations.

·         Secondary Market Trading: After shares are listed, investors can trade them in the secondary market. Prices vary depending on company performance, market sentiment, and macroeconomic influences.

 

4.2.                  Bond Trading

Bonds are forms of debt securities that are issued by governments, municipalities, or corporations to raise funds. When investors purchase bonds, they are essentially lending money to the issuer in return for periodic interest payments (coupons) and the return of the principal amount at maturity.

·         Government Bonds: These are issued by the government to fund public spending. They are regarded as low-risk investments.

·         Corporate Bonds: These are released by companies to secure financing. Corporate bonds have higher risks compared to government bonds, but they provide higher returns.

4.3.                  Derivatives Market

While it is still developing, the derivatives market in Pakistan enables traders to participate in contracts based on the value of underlying assets such as stocks, commodities, and currencies. These financial instruments are frequently utilized for hedging or speculative purposes.

4.3.1. Futures Contracts:

Futures Contracts on the Pakistan Stock Exchange (PSX)

Futures contracts are financial agreements between two parties to either buy or sell an underlying asset (like stocks, commodities, or indices) at a predetermined price at a designated time in the future. These contracts are standardized and traded on exchanges, including the Pakistan Stock Exchange (PSX). In the PSX, futures contracts are primarily employed for hedging and speculative activities, providing investors with opportunities to manage risk and benefit from price changes.         

 Overview of Futures Contracts

A futures contract is a binding legal agreement that requires the buyer to acquire and the seller to provide an asset at a specified price and date in the future. These contracts are standardized regarding contract size, expiration date, and the underlying asset. Unlike forward contracts, which are private and tailor-made, futures contracts are exchanged on markets, which enhances liquidity and transparency in the process.

            Futures Contracts in the Pakistan Stock Exchange (PSX)

The PSX Futures Market allows investors to trade futures contracts on a range of assets, primarily focusing on stock indices. Futures trading in PSX provides investors with the means to leverage their positions, hedge against market risks, and capitalize on price movements in a regulated and standardized setting.

Futures contracts on PSX are typically based on the KSE-100 Index, which monitors the performance of the top 100 companies listed on the PSX by market capitalization.

4.3.1.1.   Types of Futures Contracts Traded on PSX

4.3.1.1.1.              Index Futures

The most commonly traded type of futures contract on PSX is index futures, where the underlying asset is a stock market index (typically the KSE-100 Index).

An index future provides investors the opportunity to speculate on the future movement of the stock market index without the need to buy or sell individual shares.

For instance, KSE-100 Index Futures enables traders to predict the potential direction of the market by buying or selling contracts based on the anticipated value of the index on a designated future date.

 

4.3.1.1.2.              Single Stock Futures

PSX also supports the trading of single stock futures, where the underlying asset consists of a specific stock rather than an index.

These contracts allow traders to speculate on the price fluctuations of a particular stock, such as Oil and Gas Development Company (OGDC), Hub Power Company (HUBC), or Pakistan Telecommunication Company Limited (PTCL), among others.

Trading individual stock futures provides the capability to take positions on specific companies within the market.

 

4.3.1.1.3.             Commodities Futures

While not as commonly traded as equity-related futures, PSX also permits the trading of futures contracts linked to commodities.

These may encompass agricultural goods, metals, and energy commodities. However, the growth of the commodities futures market in Pakistan remains in its early stages compared to equity-based futures.

 

4.3.1.2.   Mechanics of Futures Contracts

4.3.1.2.1.             Contract Specifications

Futures contracts on PSX are standardized, meaning the contract specifications—including contract size, tick size (the minimum price movement), and settlement mechanism—are predefined.

·         Contract Size: The size of a futures contract specifies how much of the underlying asset is covered by the contract. For example, an index futures contract on the KSE-100 could represent 10 units of the index.

·         Tick Size: This represents the minimum price movement permissible for the futures contract. For instance, if the tick size is 1 point, the futures price can only adjust in increments of 1 point.

·         Settlement Date: Futures contracts feature a designated expiry date, which is the date when the contract is settled.

 

4.3.1.2.2.             Margin Requirements

·         Initial Margin: Futures trading necessitates that investors deposit an initial margin with the broker. This serves as a security deposit intended to cover potential losses.

·         Maintenance Margin: This is the minimum balance required in the account to keep an open futures position. If the margin drops below this threshold due to losses, the investor must deposit additional funds (referred to as a margin call) to restore the balance to the required level.

 

4.3.1.2.3.             Leverage

·         A critical aspect of futures trading is the employment of leverage. Since investors only need to provide a small fraction of the contract value as margin, they can manage a larger position in the market.

·         Leverage has the potential to magnify both gains and losses. While it offers opportunities for substantial profits, it also heightens the risk of significant losses, particularly if the market shifts against the trader’s position.

 

4.3.1.3.   Settlement of Futures Contracts

·         Cash Settlement: The majority of futures contracts traded on PSX are settled in cash, which means that the cash equivalent of the difference between the contract price and the market value of the underlying asset at expiration is paid.

·         Physical Settlement: In certain instances, futures contracts can be physically settled, indicating that the actual delivery of the underlying asset takes place at maturity. However, physical settlement is uncommon in PSX futures.

 

4.3.1.4.   Role and Benefits of Futures Contracts

                                        Futures contracts on PSX provide various functions for both individual and                                         institutional investors:

 

4.3.1.4.1.             Hedging

·         Risk Management: Futures contracts offer a mechanism for investors to hedge against potential price variations in the underlying assets. For instance, an investor holding a significant amount of shares in a company may use futures to shield against unfavorable price shifts in the stock market.

·         Commodity Hedging: Enterprises involved in commodities (such as agricultural goods or oil) can utilize futures contracts to secure prices, thereby safeguarding themselves from price volatility in the commodities markets.

 

4.3.1.4.2.             Speculation

·         Investors and traders may assume speculative positions in futures contracts to gain from price fluctuations in the market. Speculators do not plan to accept delivery of the underlying asset but seek to profit from changes in the asset's price.

·         For instance, an investor might take a long position in a futures contract on the KSE-100 index if they anticipate that the market will increase in the near future.

 

4.3.1.4.3.             Leverage and Capital Efficiency

Futures contracts enable traders to take more substantial positions with a smaller initial investment, resulting in capital efficiency. By utilizing leverage, traders can enhance their returns, though it also increases the associated risks.

This capital efficiency renders futures contracts a desirable option for many investors looking to assume large positions without committing significant amounts of capital.

 

4.3.1.5.   Futures Trading Process on PSX

 

4.3.1.5.1.             Opening an Account

To engage in futures trading on PSX, investors must establish a trading account with a licensed futures broker. The broker will help in the process of buying and selling futures contracts.

 

4.3.1.5.2.             Placing Orders

After the account is established, investors can submit buy or sell orders for futures contracts via their broker. The orders can be either market orders (to be executed at the prevailing market price) or limit orders (to purchase or sell at a designated price).

 

4.3.1.5.3.             Monitoring and Managing Positions

Investors can track their positions in real time through the broker’s platform, which supplies updated details on the prices of futures contracts, margin requirements, and potential gains or losses.

 

4.3.1.5.4.             Closing the Position

An investor has the option to close their futures position before the contract reaches expiration by taking the opposite position. For example, if an investor purchased a KSE-100 index futures contract, they can sell the same contract prior to its expiry to finalize their position and secure profits or losses.

 

4.3.1.6.   Risks Associated with Futures Contracts

While futures contracts provide numerous advantages, they also carry inherent risks, particularly because of the leverage involved:

·         Market Risk: Movements in the underlying asset's price may oppose the trader’s position, leading to losses.

·         Liquidity Risk: In certain situations, futures contracts might not possess adequate liquidity, making it challenging to close positions at favorable prices.

·         Leverage Risk: Although leverage enhances potential gains, it can also heighten the risk of substantial losses. If the market shifts against a leveraged position, the trader could forfeit more than the original margin.

 

4.3.2.                        Options Contracts on the Pakistan Stock Exchange                     (PSX)

An options contract is a form of derivative that grants the buyer the right, but not the duty, to purchase or sell an underlying asset at a set price, on or before a specific expiration date. Unlike futures contracts, which require the buyer and seller to engage in a transaction, options offer the holder greater flexibility. In Pakistan, options trading remains in a developmental stage, yet it is becoming increasingly essential in equipping investors with tools for hedging, speculation, and portfolio management.

 

4.3.2.1.   Introduction to Options Contracts

Options are financial instruments whose value is derived from an underlying asset, such as stocks, indices, commodities, or other financial instruments. These contracts provide the buyer the right (but not the duty) to execute the contract at a predetermined price (the strike price) within a specified timeframe (the expiration date).

 

             4.3.2.2.   Overview of Options Trading in PSX

The Pakistan Stock Exchange (PSX) launched options contracts as part of its initiatives to diversify its financial instruments and entice institutional and retail investors. Options trading on PSX provides avenues for speculation, risk management, and enhancing portfolio strategies. Initially, the options market in Pakistan has been limited but is gradually gaining momentum among professional traders and institutional investors.

 

4.3.2.3.   Mechanics of Options Contracts

 

Several crucial terms define an options contract, which includes:

·         Underlying Asset: The asset that the option grants the right to buy or sell. On PSX, these are typically based on stocks or indices, with the KSE-100 Index being one of the most frequently used underlying.

·         Strike Price: The predefined price at which the option buyer has the right to buy (for a call) or sell (for a put) the underlying asset.

·         Expiration Date: The date upon which the option loses validity. Following this date, the option becomes null.

·         Premium: The amount paid by the buyer to the seller (also referred to as the writer) for the option contract. The premium is influenced by various factors, including the current price of the underlying asset, strike price, time to expiration, and market volatility.

·         Option Style: There are two prevalent types of options based on their method of exercise:

·         American-style Options: These can be exercised at any moment prior to or on the expiration date.

·         European-style Options: These can solely be exercised on the expiration date itself.

 

4.3.2.4.   Options fall into two primary types:

·         Call Options: Provide the holder the right to purchase the underlying asset at the strike price.

·         Put Options: Grant the holder the right to sell the underlying asset at the strike price.

4.3.2.4.1.             Call and Put Options

 

·         Call Option: Provides the buyer with the right to acquire the underlying asset at the strike price before the option reaches its expiration. Call option purchasers anticipate that the price of the underlying asset will increase. 

·         Example: If an investor obtains a call option for a stock with a strike price of Rs. 200, they possess the right to purchase the stock at Rs. 200 prior to the expiration date. If the stock price increases to Rs. 250, the option holder can exercise the option, acquiring it at Rs. 200 and selling it at Rs. 250 for a profit. 

·         Put Option: Grants the buyer the right to sell the underlying asset at the strike price before it expires. Buyers of put options foresee the price of the underlying asset declining.

·         Example: If an investor secures a put option for a stock with a strike price of Rs. 150, they hold the right to sell the stock at Rs. 150 before the expiration date. If the stock price falls to Rs. 100, the option holder can exercise the option, selling at Rs. 150 for a profit.

 

4.3.2.5.   How Options Work on PSX

On the Pakistan Stock Exchange, options contracts are generally based on specific stocks or stock indices. The majority of the options contracts traded in PSX are KSE-100 Index options, representing a collection of the top 100 companies listed on the exchange.

 

4.3.2.6.   Trading Process of Options

·         Opening an Options Account: For trading options on PSX, investors must establish an account with a registered broker who is authorized to manage options trading. Brokers provide platforms that allow investors to place orders for options contracts.

·         Placing Orders: Investors issue either buy-to-open or sell-to-open orders to enter a position in an option. When purchasing, the investor is assuming a long position (the right to buy or sell). When selling, they are undertaking a short position (the obligation to fulfill the contract if exercised).

·         Premium Payment: The option buyer is required to pay the premium to the seller (writer) of the option. The option seller takes on the obligation to fulfill the contract if the buyer opts to exercise the option.

·         Exercising the Option: If the buyer elects to exercise the option, the seller is obligated to adhere to the contract terms. If the option is not exercised, it becomes worthless at expiration, and the seller retains the premium.

·         Settlement: Options on PSX are generally cash-settled instead of physically settled. This signifies that at expiration, the difference between the option’s strike price and the market price of the underlying asset is disbursed in cash to the option holder.

 

4.3.2.7.   Expiration and Settlement

Options contracts come with a specified expiration date, usually monthly, though weekly options might also be an option. Upon expiration:

If the option is in the money (the current price of the underlying asset is advantageous in relation to the strike price), exercising the option is likely.

If the option is out of the money (the current price of the underlying asset is disadvantageous), the option becomes worthless at expiration, and the premium paid is forfeited.

 

4.3.2.8.   Pricing of Options

The price (or premium) assigned to an option is affected by various factors:

·         Intrinsic Value: The worth that an option holds if it is exercised right away. For instance, a call option is considered in the money if the market price exceeds the strike price.

·         Time Value: The worth of the option determined by the remaining time until expiration. The longer the duration until expiration, the greater the time value, since there is increased potential for favorable price movement of the underlying asset.

·         Volatility: The volatility associated with the underlying asset plays a role in determining the premium. Higher volatility in assets leads to elevated premiums due to an increased chance of price fluctuations.

·         Interest Rates: Variations in interest rates can affect option pricing, especially for options with a longer duration, as they impact the expense of holding the underlying asset.

 

4.3.2.9.   Strategies Involving Options

Options can be employed in diverse strategies to match different levels of risk tolerance and market situations:

 

4.3.2.9.1.             Hedging

Investors utilize options to hedge their current positions. For instance, an investor who owns stocks and is concerned about a downturn might purchase put options as protection against falling prices. This technique is referred to as protective put.

4.3.2.9.2.             Speculation

Traders apply options for speculation on the anticipated price direction of an asset. If an investor expects the price of a stock to increase, they may acquire a call option to gain from the price rise. Conversely, if they forecast a decline in price, they might opt for a put option.

4.3.2.9.3.             Covered Call

A covered call strategy entails holding a long position in an asset (like a stock) while simultaneously selling call options on that same asset. This conservative tactic aims to generate extra income from the premium acquired through selling the call option.

4.3.2.9.4.             Straddle and Strangle

·         Straddle: This strategy involves an investor purchasing both a call and a put option with identical strike price and expiration date. It yields profit when the underlying asset exhibits considerable price movement in either direction.

·         Strangle: This resembles a straddle but has distinct strike prices for the call and put options. This strategy also benefits from substantial price movements but is typically less expensive than a straddle.

 

4.3.2.10.                      Risks Involved in Trading Options

Trading options can provide significant profit potential, but it is also associated with considerable risks:

·         Premium Loss: The clearest risk for buyers of options is the potential forfeiture of the premium spent on the option if it becomes worthless upon expiration.

·         Leverage Risk: As options provide leverage, both profit and loss potential are magnified. A minor price fluctuation in the underlying asset can lead to substantial gains or losses.

·         Time Decay: As the expiration date nears, the time value of an option diminishes, a phenomenon referred to as time decay. If the price of the underlying asset fails to move in the anticipated direction, the option holder might lose the premium as a result of time decay.

·         Liquidity Risk: The market for options in PSX is still evolving, and there may be periods when liquidity is reduced, making it challenging to enter or exit positions at advantageous prices.

 

4.4.                  Mutual Funds and ETFs

Investors can also engage in trading mutual funds and exchange-traded funds (ETFs) on the PSX. These funds gather capital from several investors to invest in a varied portfolio of stocks, bonds, or other assets.

·         Mutual Funds: These funds are overseen by professional fund managers and can be managed either actively or passively.

·         ETFs: These funds resemble mutual funds but are traded on the stock exchange like individual shares.

 

4.5.                  Commodities Market

Though still relatively new, PSX is looking into the creation of commodity trading across various sectors such as agriculture and energy. This market enables the trading of physical items like wheat, rice, and oil.

 

5.           Shares and Bonds in Pakistan Stock Exchange

 

5.1.                  Shares

Shares denote ownership in a corporation. When an investor purchases shares of a corporation, they acquire partial ownership and can profit from the corporation’s success through capital gains and dividends.

5.1.1.                        Types of Shares:

Ordinary Shares: Often referred to as common stock, these shares grant the shareholder voting rights at annual meetings and entitlement to dividends.

·         Preference Shares: These shares provide investors with precedence in dividend payments, but generally do not grant voting rights.

·         Share Price: The valuation of shares varies based on multiple factors, including the corporation’s performance, economic conditions, investor sentiment, and the dynamics of supply and demand within the market.

 

5.2.                  Bonds

Bonds are debt instruments that enable investors to loan money to an issuer (either the government or a corporation) in return for regular interest payments and repayment of the principal amount upon maturity.

·         Government Bonds: Released by the government, these bonds are regarded as low-risk investments. Examples include Pakistan Investment Bonds (PIBs) and Treasury Bills (T-Bills).

·         Corporate Bonds: Issued by private companies, these bonds offer higher yields but also come with increased risk.

·         Bond Ratings: Credit rating agencies assign ratings to bonds based on the issuer’s capability to settle the debt. Ratings range from AAA (highest) to D (default).

5.3.                  Bonds in Pakistan

·       Sukuk Bonds: A distinctive type of bond in Pakistan, sukuk bonds are Islamic financial instruments that adhere to Shariah law. Instead of accruing interest, they provide profit-sharing and are secured by tangible assets.

6.          Regulatory Authorities and Market Governance

The Securities and Exchange Commission of Pakistan (SECP) acts as the main regulatory authority overseeing the operations of the PSX. The SECP implements regulations, supervises trading activities, and safeguards investor interests. Additionally, the PSX is supervised by a board of directors that ensures its effective operation.

 

7.          Challenges Faced by the Pakistan Stock Exchange

In spite of its vital role, the PSX encounters several challenges:

·         Volatility: The PSX frequently experiences price swings due to political instability, economic unpredictability, and various other factors.

·         Liquidity Issues: Although the PSX has expanded in recent years, liquidity continues to be a concern, as there is a limited number of investors and market participants.

·         Lack of Awareness: There exists a limited level of public knowledge and awareness regarding stock trading, which hinders the growth of retail investors in Pakistan.

·         Regulatory Issues: While the SECP is essential in overseeing the market, there are worries regarding the adequacy of regulations in preventing market manipulation and fraudulent activities.

 

Conclusion

The Pakistan Stock Exchange is crucial to Pakistan’s economic advancement by offering a platform for the effective distribution of capital, promoting investment, and aiding economic expansion. As the nation progresses in modernizing its financial markets, the PSX holds the possibility of becoming a more prominent player internationally. Nevertheless, enhancements in liquidity, investor education, and market regulations are necessary to guarantee sustainable growth and stability moving forward.