There have been growing voices within the government and the regulators over the surge in retail interest in the derivatives market. Finance Minister Nirmala Sitharaman raised the STT (Securities Transaction Tax) on futures and options in the Budget and the Securities and Exchange Board of India (SEBI) earlier this week released a consultation paper proposing several changes to curb the euphoria.
On the one hand, these measures are justified on the grounds of huge losses investors are incurring in F&O (futures and options). On the other hand, there is also criticism from some sections who feel this will have an adverse impact on the wider derivatives market, which has seen strong growth over the last several years.
On Friday, Ananth Narayan G., a whole-time member of SEBI stressed that the concerns were mainly pertaining to the surge in index options volumes, which he says resembles "a slot machine in a casino, with individuals putting coins into the machine, hoping to hit the jackpot."
An index option is a derivative instrument where the value is derived from the moves in the underlying index like the Sensex or Nifty. Here the holder has the right, but no obligation, to buy or sell the value of the index.
He pointed out that while cash market annual turnover increased by just over 2 times between financial years 2020 and 2024, index options annual turnover on a premium basis had risen by over 12 times from Rs 11 lakh crore in FY20, to Rs 138 lakh crore in FY24. It is worth noting that index futures turnover did not change much during the same period, he added.
What explains this explosion in index option volumes? The proliferation of weekly expiries for index option contracts, to a stage where every day of the week has an index option expiry, has clearly had a role to play, pointed Narayan.
He also noted that there are contracts where well over 90 per cent of the trading volume in index options occurs on the expiry day, with a significant concentration in the last hour of trading.
"This frenzied hyperactivity in index options on expiry day has little discernable benefits while raising several issues. The frenzied trading on expiry day, also raises questions of market stability and possible vulnerability to manipulation," said Narayan.
NSE data shows over 92 lakh individuals collectively lost Rs 51,869 crores during FY24 in index derivatives, and this was without even considering transaction costs.
"As a regulator, we are conscious that we must not throw the baby out with the bathwater. When it comes to the frenzied trading in options nearing expiry, however, it is very difficult to see any baby in this bathwater," he said.
The primary regulatory intent is to specifically curb only this expiry day frenzy in options trading, and to reduce the systemic risks around this, he stressed.
He pointed out five of the seven proposals that the July 30 consultation paper has put out –i.e., restricting the number of weekly option expiries, increasing margins around expiry day, removing the benefit of calendar spreads on expiry day, requiring the monitoring of intraday positions, and rationalisation of options strikes – are centered around this objective.
"We have taken care to ensure that the steps do not restrict avenues for trading, market making, or hedging in the broader F&O ecosystem," he stated.
SEBI will continue to monitor activity in F&O markets, and in a consultative fashion, consider fresh steps as necessary, even after the current round of consultations and final measures that are announced, he added.
