As Sebi comes down hard on speculative trading in derivatives, investors turn to other options

Margin trading facility, or MTF, is considered safer, offers higher leverage, and includes a broader range of stocks. While option traders typically prefer trading in indices, an MTF is geared towards individual stocks.

The Securities and Exchange Board of India is seeking to curb “excessive speculation" by retail, or individual, investors in the higher-risk derivatives market (futures and options). In a study, Sebi pointed out that more than 90% of retail investors had lost money in the derivatives market.

Market experts say Sebi’s recent regulatory moves could cause a dent in overall F&O trading volume, compelling individual investors to seek other routes.

A section of retail investors may gravitate towards margin trading facility as it has similar margins as F&O and offers a higher number of stocks to trade in, along with leverage, said Sandip Raichura, chief executive officer-broking and distribution, and executive director, at stock broking firm Prabhudas Lilladher. 

“This would be a good move from a risk-management perspective," Raichura said. “MTF is leveraged, and the risk is lesser due to higher margins, as well as (because it would involve) a mindset shift from daily (mark-to-market) management to managing an ‘investment portfolio’."

Mark-to-market refers to adjusting the ‘fair value’ of an asset to reflect its current market price.

Also read | Retail investors and the draw of options trading, and why regulators are worried

Margin trading facility is considered a safer leveraged product from a systemic-risk perspective because strict margin procedures are already in place, explained Ashish Rathi, whole-time director at HDFC Securities Ltd. Moreover, brokers backed by banks are more likely to have the financial appetite to fund such trades, he said.

F&O involves a different risk mechanism. Apart from futures, there are options, which allow customers to take short positions, which is not possible in MTF, Rathi pointed out.

Currently, the size of the margin trading facility book in India’s stock market is about ₹73,500 crore, Rathi said.

The MTF operandi

This is how a margin trading facility typically works. A client with ₹100 can trade for ₹500 worth of stocks, with their broker paying the remaining ₹400. Here, the upfront margin is ₹100. 

This margin is determined by a stock exchange for each stock and changes daily as a percentage. For instance, a client must pay an upfront margin of 12.5% for trading in shares of Reliance Industries Ltd, and 100% for Exicom Tele-Systems Ltd. 

Unlike with MTF, F&O does not involve borrowing from a broker. Instead, traders agree to buy or sell securities, assets, or commodities on a set date.

While the upfront margin is provided by brokers, the leverage is funded by non-banking financial companies. The interest on this leverage is relatively high, ranging from 16-24%, according to a member of the Brokers Committee. Most brokers have tie-ups with NBFCs, this person told Mint.

A net neutral for customers

India’s derivatives market has faced a raft of recent regulatory changes, including the implementation of 50% cash margin requirements, “true to label" transaction charges that could signal the end of zero or low brokerage, and a 90% price cap on listings for small and medium enterprises in the pre-open window. 

An expert panel from Sebi will convene on 15 July to explore measures to reduce risks in the equity derivatives market. The agenda may include discussions on increasing lot sizes, strengthening client due diligence, enhancing margin requirements, restricting expiry options, and increasing strike price intervals.

In May, the average daily turnover on the National Stock Exchange’s cash market increased by nearly 6% month-on-month to ₹1.12 trillion. The average daily turnover in the equity options segment rose by about 8% month-on-month to ₹66,882 crore, after declining in the previous two months.

But the average daily turnover in the equity futures segment saw only a modest increase of 0.8% month-on-month, reaching ₹1.94 trillion.

Also read | F&O trading: Do retail investors really need Sebi's big brother oversight?

Still, Parminder Varma, whole-time director and chief business officer of Sharekhan by BNP Paribas, believes Sebi’s recent regulations would impact more small traders active in the market.

“Today, 80-90% of the volume is related to only 2 lakh (200,000) very active/large clients," Varma said. “Younger traders might not be able to bring in higher margins if the new regulations ask for that, and this will reduce their participation. But serious traders will gradually adjust to the new regulations and aim to still find their opportunities."

Ashish Nanda, president and head of digital business at Kotak Securities Ltd, said Sebi’s recent guideline asking market infrastructure institutions to charge flat rates instead of slab-wise rates would bring transparency. 

“From a client perspective, exchange turnover charges will reduce, but brokers may increase their brokerage, and hence it should ideally turn out to be net neutral for customers," Nanda said. This is unlikely to have an impact on options volumes or shift volumes to the cash segment or margin trading facility, he added.

Jay Prakash Gupta, founder of online trading and investing platform Dhan, pointed out that while option traders typically prefer trading in indices, MTF is geared towards individual stocks. And that implies such traders are still likely to stick with F&O for now.

Retail investors on the backfoot

Sebi in a recent circular also limited the stocks that can be used as collateral based on impact cost, and will cut the list of acceptable securities by about 1,010, from over 1,700 now.

Brokers will have to update the list of acceptable securities that they accept from clients accordingly, said Nanda. “In my view, this can have some impact on overall reduction of volumes in cash, MTF, and futures, but not too significant."

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Tejas Khoday, co-founder and CEO of online discount brokerage Fyers, believes the recent wave of regulations targeting speculation-based trading in the F&O segment could potentially reduce the depth of the Indian stock market and deter retail investors from trading.

Differing from the majority viewpoint, he believes F&O investors might shift to the cash market rather than to MTF. Although margin trading facility is an option, Khoday said brokers in India lack sufficient capitalisation to fund trades through this route. 

Additionally, there is a possibility that Sebi might disapprove of an increase in MTF, as its primary goal has been to reduce speculative trades. 

The end of discount broking?

In a circular issued on July 1, Sebi announced that market infrastructure institutions—such as stock brokers, depository participants, and clearing members—will now be required to levy uniform and equal charges on all members. Previously, MIIs used a volume-based slab structure for charges, which Sebi believes could prevent them from providing equal and fair access to all market participants.

As a result, discount brokerages—which heavily rely on the options trading segment—could face a revenue loss of approximately 35-50%, said Khoday.

Nithin Kamath, founder and CEO discount broking firm Zerodha, took to social media platform X saying that Sebi’s decision would have a significant impact on brokers, traders, and investors.

“With the new circular, we will, in all likelihood, have to let go of the zero brokerage structure and/or increase brokerage for F&O trades. Brokers across the industry will also have to tweak their pricing," Kamath posted on 2 July.

Also read | Sebi’s new mandate: The beginning of the end for zero brokerage fees?