Opinion
Derivatives trade: Sebi is taking a pro-market approach
Summary
- Retail investors may have wisened up lately, but their zest for derivatives remains a worry. The market regulator’s proposals to tighten futures and options eligibility can reduce risks.
If the behaviour of retail investors over the last week or so is observed, they would seem to have outsmarted professional asset managers. Take 3 June, for example, the first equity trading day after the weekend announcement of exit polls. As the market jumped more than 3% on forecasts of a big majority in Parliament for the ruling BJP, retail investors sold shares worth ₹8,587.5 crore, instead of joining the rally.
In contrast, foreign portfolio investors bought Indian shares worth ₹6,617.3 crore that day while mutual-fund purchases stood at ₹3,072.9 crore. Then, on 4 June, when the actual election results were declared and the BJP fell short of a simple majority, retail investors purchased shares worth ₹21,178.9 crore, sensing an opportunity in a market that dropped some 6% in response to that news.
Again, foreign investors and mutual funds went the opposite way, selling shares worth a combined ₹18,760 crore. The rise of stock indices in the following sessions made it clear that retail investors had played it right. But this is a rare instance of household traders emerging on top.
Also read: SEBI suggests tighter regulations for inclusion of derivative trading on individual stocks
More often, it is retail investors who end up losing, unable to time the market like professionals do and bearing more risk than they can grasp and afford. Our recent boom in the retail trading of equity futures and options (F&O) offers proof of reckless investing. As many as 9 out of 10 retail investors were found to have lost money in 2021-22 by a study done by the Securities and Exchange Board of India (Sebi).
This explains why Sebi now proposes to tighten stock eligibility for F&O trading. In a discussion paper released on Sunday, it broached the idea of raising the bar for its condition of sufficient liquidity and trading interest in stocks for derivatives of these assets to be traded.
“Without sufficient depth in the underlying cash market and appropriate position limits around leveraged derivatives, there can be higher risks of market manipulation, increased volatility, and compromised investor protection," Sebi said.
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For a stock to qualify for the F&O segment, the regulator wants a checklist met that would include not just criteria like it being traded for at least 75% of all trading days with 15% of active derivative traders having traded it across a span of time, but also higher limits for average daily turnover of cash trades and contract premiums, apart from a larger range of open F&O contracts on a rolling basis.
Market participants need not get into the finer details of Sebi’s proposals to get the drift. They basically aim to keep out shares that may be too risky for retail appreciation. F&O trading volumes are estimated to have shot up 20 times since their pre-covid level, thanks to a retail frenzy that has made India a global outlier on this.
What makes these trades so attractive is the chance of making outsized profits with small sums. Investors can take large bets for brief periods with little margin money in the hope of not needing to pay the full money as net positions get settled. But the risks can be very deceptive and tend to catch most lay investors unaware.
Also read: Margin calls by brokers heightened volatility
Sebi is welcome to tighten the screws on trades that can hardly be distinguished from gambles. The F&O segment is meant to enrich the overall quality of market information and induce efficiency. Instead, we face the need to pre-empt a crisis arising from an insurge of retail investors who may be clueless of how reckless they are being. In general, we need deeper financial markets. But not like this.
