How derivatives bring out the gambler inside, and how to stop it

Derivatives are meant to be hedging instruments, but investors worldwide use them as speculative tools and India is likely no exception, the Economic Survey said, at a time the stock market regulator is weighing measures to curb ballooning retail speculation in the segment.

However, the survey added that raising investor awareness and continuous financial education are essential, since it will be a loss to the economy if investors scarred by steep losses leave the market.

“Most of the new retail investors are likely young and may have a higher risk appetite. It is also reflected in the interest that retail investors have shown in derivatives trading, especially expiration-day trading (weekly options’ expiry)," the survey said.

The survey added that as derivatives hold the potential for outsized gains, it caters to humans’ “gambling instincts” and could “augment income if profitable.” These considerations were “driving active retail participation in derivatives trading,” it notes.

Raising investor awareness

The way to contain excessive speculation is by raising investor awareness and continuous financial education, the survey said, adding this is essential to warn them of the low or negative expected returns from derivatives trading.

“A significant stock correction could see losses that are more considerable for retail investors participating in capital markets through derivatives. Investors’ behavioural response would be to feel ‘cheated’ by unseen more considerable forces. They may not return to capital markets for a long time. That is a loss to them and the economy.”

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The survey recommendations assume importance in the light of a Sebi committee examining recommendations by former Reserve Bank of India executive director G. Padmanabhan to dissuade retail investors from trading in equity derivatives. Some of the committee's proposals include raising upfront trading margins four to five-fold by raising lot sizes and restricting weekly expiry of options to one per exchange per week instead of the current five index expiries per week.

Massive losses on investment

Speaking at an asset management committee event last week, Sebi chairperson cited massive losses suffered by a growing number of youth dabbling in derivatives in the past few years.

“It has now reached a scale where we believe that the micro-objective of protecting the individual investor has changed and morphed to thinking about (the) macro issue. Is this what our market is designed to do - facilitate a lot of speculative transaction?” she questioned.

The volumes in derivatives have surged after the covid pandemic which restricted contact and confined people to their homes.

Notional volumes of equity derivatives on NSE, which has over 90% market share, surged 2,220% from ₹3445 trillion in FY20 to ₹79,928 trillion in FY24.