FM Nirmala Sitharaman and CEA V Anantha Nageswaran recently flagged the growing risk of futures & options (F&O) trading for retail traders. Why are policymakers cautioning retail investors on F&O, also called derivatives trading? Here is an explainer:
What’s F&O trading?
Futures and options are two derivative instruments where a trader buys or sells a contract on an underlying asset at a pre-determined price. As the name suggests, derivatives are financial products that derive their value from other underlyings like stocks, bonds, commodities etc.
What are futures and options?
Futures are derivative contracts that give the buyer the right to buy a specific asset on a specific date at a specific price from a seller, unless that contract is sold off to someone else or closed. On the other hand, an options contract gives the buyer the right to buy or sell a specific asset at a specific price on or before the last date of the contract (called date of expiry). In options contracts, the buyer has the right but not an obligation to buy or sell the specific asset. An options seller has the obligation to deliver the assets to the buyer but no right to deny selling that.
When you buy an airline ticket…
A train or a flight ticket gives the passenger (the buyer) the right to travel on a specific date but no obligation to do the same. At the last moment, the passenger could cancel the ticket or abandon the travel plan. On the other hand, the railways or the airline (the seller) has an obligation to provide the passenger the service on the specific day and the time for which the ticket was bought. The seller has an obligation to provide the service but has no right to cancel the ticket unless under extreme circumstances. So we use options in our lives, but some options are not traded on an exchange.
Why is govt concerned about F&O trading by retail investors?
F&O trading is being used primarily as a speculative tool to make a quick buck in the stock market. But the reality is that most retail investors are losing money. In Jan 2023, Sebi came out with a study that showed 89% of the people in the F&O space were losing money. That means only one in 10 people made money. But F&O trading volumes are rising at a pace that surprises market veterans.
How has F&O trading turnover grown in recent years?
According to NSE, between March 2020 (i.e. just before the pandemic started) and March 2024, its monthly derivatives turnover has grown 30 times: From Rs 247.5 lakh crore to Rs 7,218 lakh crore. On the BSE, from a turnover of about Rs 1 lakh crore in March 2020, the total turnover in the segment reached a high of Rs 1,519 lakh crore — a jump of over 1,500 times. Compared to turnover in the cash segment of the market, F&O turnover is hundreds of times more.
Is increase in turnover the only concern?
No. The huge spurt in volumes has also brought in a large number of fake and fraud operators in the market. Using various social media platforms, they induce people into F&O trading by showing and promising very high and unreasonable profits. They often use pictures and videos of celebrities and top business leaders to induce investors to fall into their net. At times, they also use screenshots of huge profits (called fake profit & loss or P&L screenshots) to prove their expertise to attract retail investors to trade according to their recommendations. Investors fall for such tricks without realising that these fraudsters are the people on the other side of the trade who are making money. Several finfluencers (financial influencers) are also involved in such acts.There are also cases where large foreign players are making huge money trading Indian F&O products. For one such profits are accruing mostly at the expense of small Indian traders in the F&O space. Second, this money is flowing out of India.
How are investors reacting to it?
The lure of money is getting a large number of investors to F&O trading. Most of this growth is coming from the Tier 2 and Tier 3 places, mostly with poor knowledge of the risks, the trading strategies etc. Some minors are also using the accounts of adult relatives or acquaintances to trade in the market since they can’t do it till they turn adult.
What could Sebi and govt do?
Market veterans say Sebi and the govt could tighten the rules for F&O trading by increasing margins, put in higher networth requirement for traders in the F&O space and also make some basic certification compulsory for people in this segment.
