F&O: Time to curb retail frenzy

Finance Minister Nirmala Sitharaman had earlier flagged the increasing retail participation in the derivatives market as a cause for concern. “An unchecked explosion in retail trading in the futures and options (F&O) market can create future challenges for the market, investor sentiment and household finances,” Sitharaman said at an event held at the BSE a few months ago. Securities and Exchange Board of India (Sebi) chairperson Madhabi Puri Buch now says that households are losing up to Rs 60,000 crore a year in the problematic F&O segment. 

Sebi has now proposed a series of short-term measures to curb speculative trading in index derivatives (F&O), including restricting multiple option contract expiries, raising the size of options contracts and intraday monitoring of position limits. These measures may not be sufficient to curb the retail frenzy in the index options & futures segment. Sharing his comments on Sebi’s consultation paper on F&O trading, Nithin Kamath, founder of Zerodha, said the proposed changes will not significantly impact options volumes but could reduce futures volumes.

Retail frenzy in options trading has taken off after the NSE introduced the weekly options contracts on indices. Last year, Indian investors traded 85 billion options ­contracts, more than anywhere else in the world. A frenzied growth in India’s equity options market is unnerving policymakers and regulators. The NSE launched the weekly options on the Nifty 50 Index in Feb 2019, following the success of Bank Nifty weekly options, which were launched in 2016. Weekly option contracts are often referred to as ‘Hero or Zero’’ options because the premium paid can either become worthless (zero) or multiply significantly.

Weekly option contracts on indices are intended to provide an additional hedging tool for market participants to manage portfolio risks more effectively. The average value of the equity portfolio of retail investors is modest. They do not need to hedge their portfolio risks on a weekly basis as the hedging costs will erode their investment values. Such hedging tools may be required only for institutional investors. Originally designed as a risk-hedging tool, weekly options have now become speculative bets and an addiction for many retail investors.

The lure of derivatives partly comes from the leverage they offer. Simply put, leverage allows you to gain exposure to a larger value by committing only a fraction of it. With a premium payment of a few thousand rupees, a retail investor can buy an index option contract with an underlying value of a few lakhs of rupees. Writing (or selling) options) is typically reserved for big players as it requires substantial margin money.

Much like junk food served by quick service restaurants, weekly option contracts served in the stock markets are not good for the long-term financial health of retail investors. 

A Sebi study revealed that nine out of 10 individual traders in the equity F&O segment incurred net losses from FY19 to FY22. The study, based on a sample of all individual clients of the top-10 stock brokers, found that 98% of these retail traders traded in options, while 11% traded in futures in FY22. The number of individual traders in the equity F&O segment surged by 500%, rising from 7.1 lakh in FY19 to 4.5 million by the end of FY22.

“The Sebi findings highlight that the odds are not in favour of active trading and one should focus on compounding by investing mindfully in well-researched stocks or simply parking money in ETFs and index funds,” said Abhilash Pagaria, head of Nuvama Alternative & Quantitative Research.

The F&O segment is not an effective hedging tool for retail investors. Weekly index option contracts often fuel greed and ambition, leading retail investors to seek quick profits in an hour or a day, but they invariably end up losing money. Futures & Options is more like gambling than investing. Retail traders generally lack the agility, tools and financial resources to capitalise on the fleeting opportunities flashing momentarily on charts.

It is high time for policymakers to reconsider allowing retail investors access to weekly index options, to protect them from financial losses and safeguard their livelihoods. For genuine hedging purposes, retail investors can always use near-month or far-month option contracts.

(The writer is a retired corporate professional)