A regular client managing a large corpus in corporate bond funds calls you, worried that a sudden shift in RBI monetary policy might erode his portfolio value. He asks why his hedge using interest rate futures seems to fluctuate more frequently than his daily mutual fund NAV, even when the overall interest rate environment appears stable. You realize he is observing the impact of high-frequency participants who utilize the smallest possible price increments to capture micro-arbitrage opportunities.
In the Indian derivatives market, the tick size represents the minimum price movement allowed, and for a retail-focused distributor, this is the first point of contact with market microstructure.
While mutual funds are valued daily based on the underlying portfolio’s mark-to-market, exchange-traded futures move in discrete steps defined by the tick size. High-frequency traders and automated algorithms thrive on this granularity, as they can execute thousands of trades to capture tiny price differences that aggregate into significant margins over a trading session.
For your client, this means that even if the macro view on interest rates hasn’t shifted, the short-term price of the future will jitter based on the liquidity and volume of these fast-paced traders. Failing to explain this can lead to client panic, as they might mistake standard market noise for a signal that their hedging strategy is failing.
As a distributor, you must bridge this gap by explaining that the tick size acts as the liquidity filter of the market. When liquidity is high, orders are filled across many price levels within the tick range, keeping the market stable. However, when market participants are sparse, the price jumps by full ticks, which can lead to unexpected slippage for a client trying to enter or exit a hedge.
This is why we advise investors to use limit orders rather than market orders in thinly traded IRF contracts, as it protects them from executing at a disadvantageous price tick during a sudden market dip.
By helping clients distinguish between ‘market noise’ driven by high-frequency trading and fundamental shifts in yield curve expectations, you solidify your role as a trusted advisor. Always remind your clients that while the tick size is a technical parameter of the exchange, its real-world effect is on the cost of execution. A client who understands that they are playing in a market where seconds and ticks matter is far less likely to call you during minor bouts of intraday volatility.
Nuance
Check Your Understanding
An investor wants to hedge their debt portfolio using GOI Bond Futures. They notice that the price is fluctuating in increments of Rs 0.0025. What is the most likely consequence of high-frequency trading on the investor’s hedging strategy?
If the tick size for a bond future contract is Rs 0.0025 and the lot size is 2,000 units, what is the change in the contract value for a 10-tick movement?
This is a companion read for Section 20.4 — Lot Size, Tick Size and Change in Contract Value for each Tick change from Pass Certification Examination for Mutual Fund - Specialized Investment Fund Distributors by Akhilesh Gururani, available on Amazon Kindle.
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