Understanding RIL-RE trading on Day 1 and what it means

The first day of RE trading gave a picture of the fairly large volumes with institutions like Bank of New York and SOCGEN putting in bulk trades on the RE counter. How should traders interpret the pricing of the Rights Entitlements (RIL-RE) and what happens when you buy or sell the RE in the market.

May 21, 2020 01:05 IST India Infoline News Service

On May 20, the Reliance Rights Entitlements (RIL-RE) officially started to trade on the NSE and the BSE in the trade-to-trade (T2T) segment. The first day of RE trading gave a picture of the fairly large volumes with institutions like Bank of New York and SOCGEN putting in bulk trades on the RE counter. How should traders interpret the pricing of the Rights Entitlements (RIL-RE) and what happens when you buy or sell the RE in the market.

Remember, the RE can only be traded on the exchange till the close of trading on May 29. Before that date, those who are holding the RE must take a decision on whether they want to renounce the RIL-RE by selling it in the market or whether they want to exercise the RE in exchange of RIL shares.

Why did the RIL-RE trade at a premium to intrinsic value?

At the close of trading on 20 May, Reliance stock was trading at Rs1437. Since the rights price is Rs1257, the intrinsic value of the RIL-RE should be Rs180. In reality, the intrinsic value of Rs180 will not be realized by the buyer today but in 3 tranches as under.
Details First tranche: May-20 Second Tranche: Jun-21 Third Tranche: Nov-21
Actual Intrinsic Value Rs45 Rs45 Rs90
PVF at 12% discounting 1.0000 0.8928 0.8475
PV of Intrinsic  Value Rs45.00 Rs40.18 Rs76.28
Actual Value Received Rs161.46

That means the fair value of the RIL-RE at the price should be Rs161.46 and not Rs180. This should be the price at which the RIL-RE should quote as it represents the effective intrinsic value. Let us see how RIL-RE closed on May 20, 2020.
Data Source: NSE
Clearly, the RIL-RE is quoting at a premium of Rs50.59 (212.00 – 161.41) to the intrinsic value. What does this premium represent?

Premium represents volatility and time value
This premium of Rs50.59 will not be constant but will keep changing on a real time basis. The first factor is volatility. If the market expects a higher volatility in the Reliance share price, the premium assigned will be higher. Secondly, time value matters. For example, this RIL-RE is only valid till 29 May. As we approach this date, the premium will keep on diminishing just like any option contract.

What happens when you sell RIL-RE on the stock exchange?
When you sell the RIL-RE in the market, your entitlement to subscribe to the rights is reduced proportionately. For example, if you were holding 1500 shares of RIL on 14 May, your demat account would have been credited with 100 RIL-RE. If you only intend to hold 50 rights shares then you can sell 50 RIL-RE in the open market. On the T+2 date, these 50 RIL-RE would get debited to your demat account. For the balance 50 RIL-RE still in your demat account, you can apply for equivalent rights shares. Traders often wonder if they can also buy RIL-RE from a trading perspective. That is perfectly possible but being a T2T security, you have to mandatorily take delivery on T+2 date. Being marked for mandatory delivery, no intraday trades or short selling is possible.

When you buy RIL-RE; how does it work?
Like in the case of shares; when you buy RIL-RE from the open market, you will get the credit on T+2 date. But RIL-RE securities can only be purchased till May 29 after which it will be extinguished. Since RIL-RE is marked for compulsory delivery, when you buy it means someone is actually renouncing their right. The question is how this RIL-RE will rank in terms of allotment of rights shares. Here is how the waterfall works.
a) Full allotment of rights shares to those eligible equity shareholders who applied for their Rights Entitlements in full or in part. This includes the Renouncee(s) who have applied for Rights Equity Shares renounced in their favour. The allotment process will not differentiate whether you are an original allottee or renouncee.

b) The next preference will be given to eligible equity shareholders with fractional entitlements. Allotment under this head will be considered if there are any unsubscribed rights equity shares after allotment.

c) Allotment to eligible equity shareholders who having applied for all the rights equity shares offered to them as part of the Issue, and have also applied for additional Rights Equity Shares.

d) Allotment to Renouncees who having applied for all the Rights Equity Shares renounced in their favour and also applied for additional shares.

e) Allotment to any other person, that the Board may deem fit, provided there is surplus available after making Allotment under (a), (b), (c) and (d) above.

The actual rights shares will be credited on June 11 and trading on the partly paid (PP) shares shall commence on June 12.

Related Story

Open Free Demat Account (Rs699)