Opinion
F O excess: Retail investors are safer staying off derivatives and going long
Summary
- They should heed Sebi chairperson Madhabi Puri Buch’s advice. For all its speculative thrills, dallying with futures and options is way too risky. This needed to be flagged.
The Securities and Exchange Board of India (Sebi) is evidently worried about high retail participation in the derivatives segment of equity markets. Chairperson Madhabi Puri Buch’s remarks on Monday reflected this concern. “I must admit, I am always a little confused and surprised as to why people continue to [trade in futures and options], knowing that the odds are not in their favour at all," she said. Indeed, too many have joined the F&O game in recent times and it is unlikely they have fully grasped the risks they are taking for the rewards sought. A recent Sebi study revealed that the number of unique individual F&O traders swelled by over 500% during the pandemic from just 710,000 back in 2018-19. A wave of enthusiasm for equity trading was attributed to people being stuck at home with extra time and money. In general, this should have pleased any regulator keen to see more folks participate in capital markets. But F&O trading is a field for specialists, like it or not, so the retail money in play is more likely to represent reckless punts than calculated bets on price movements or other investment strategies that use derivatives to hedge risks.
Going by anecdotal evidence, the lure of making an easy buck has had a role in India’s F&O boom. Last year, a mutual fund chief spoke of being alarmed to hear people with sparse knowledge of financial markets talking about the money they made selling options—or rights to exercise equity trades later on preset terms. The risk of such dealings can also be hedged, but adverse price swings could still deliver harsh blows. For how tricky all this can prove, consider the winner-loser ratio found by Sebi’s study. Only one in every 10 individual traders made money in the equity F&O segment, while the rest lost an average of ₹1.1 lakh in 2021-22. Among active traders, the average hit taken by those who incurred losses was more than 15 times the average profit of those in the green. Clearly, the odds are stacked against retail participants. Often, they have neither a data edge nor the market expertise that institutional players possess. What still draws them to high-risk derivatives is perhaps the scope they hold for placing low-ticket, big-bounty bets on volatile asset prices. Derivative deals take little upfront money, with gains and losses to be squared only at the end of their life. On occasion, they yield outsized profits, which can have a heady effect that may interfere with rational estimates of one’s future chances. As the F&O segment’s dismal win ratio suggests, it may be easy to get drawn into over-confident trading that goes wrong more than right.
It’s good that Sebi has flagged the problem. “There is a 90% chance that the investor will lose money in the F&O segment," Buch said, “but we also know, and the data shows us, that if you take a long-term view of the market, and if you invest with a long-term perspective, you will rarely go wrong." Retail investors could quibble that their own risk of losses might well be lower, but it’s best not to let conceit get the better of her advice. Households should invest in stocks via diversified portfolios held for long periods of time, attracted by dividends more than capital gains. This is not just safe, it’s also in harmony with the role of stock markets in getting money across to businesses that make better use of it, thereby doing their bit for economic efficiency. Corporate profits have been gaining as a proportion of GDP and a safe slice of these is what most investors should aim for.
