Will There Be Regulatory Interventions In The Bloated Futures And Options Market?

“Any unchecked explosion in retail trading of F&O can create future challenges, not just for the markets, but for investor sentiments and also for household finances,” Finance Minister Nirmala Sitharaman recently said.

For good measure, she added, “Household finances have made a generational shift. We want to safeguard that and ensure that it is not going to be shattered.”

Overall Fall In Household Savings

While the participation of retail investors in stock markets is often lauded as an achievement, there are emerging repercussions on the fast-changing household sectors’ saving profile due to retail investors’ growing F&O losses.

The Ministry of Statistics and Programme Implementation (MoSPI) data revealed that household savings as a percentage of gross savings dwindled to an alarming 60.9 per cent in 2022-23. This was triggered mainly by a drastic fall in net financial savings of households—from 26.1 per cent of gross savings in 2019-20 to 17.4 per cent in 2022-23.

Financial liabilities of households jumped from 13 per cent of gross savings in 2019-20 to 17.4 per cent in 2022-23.

Soon after Sitharaman’s comments, V. Ananth Nageswaran, Chief Economic Advisor, expressed concerns as well about the burgeoning F&O trading.

“When we take pride in the fact that we have the world’s largest trading volume for F&O, we need to ask ourselves, is that a sign of progress or a sign of concern?” he said.

Why Is The Government Uncomfortable With Derivative Trading?

Derivative trading is purely speculative in nature. “Any kind of speculation is banned in India barring derivative trading and this is a cause for concern. Often investors get into F&O trading with misplaced expectations. It is dangerous and fraught with risks,” Dhirendra Kumar, CEO of Value Research told The Secretariat.

Kumar added that trading in derivatives is almost like gambling and investors need to be well educated and aware while handling these complex instruments.“While derivatives can give investors quick returns, it can also wipe out all the gains in one go,” Kumar said.

As per data by the Futures Industry Association (FIA) for calendar year 2023, the National Stock Exchange of India (NSE) was ranked the world's largest derivatives exchange by trading volume (contracts).

According to the Securities and Exchange Board of India (SEBI) 89 per cent of the individual traders (9 out of 10 individual traders) in the equity F&O segment incurred losses with an average loss of Rs 1.1 lakh during 2021-22.

In 2019, there were just 7.1 lakh individual traders dealing in F&O. The number shot up to more than 45 lakh in 2022—an increase of about 500 per cent. Analysts said it has further risen in the last few months as people are looking for quick and easy ways to make money.

Importantly, derivative trading is becoming more and more attractive for young investors between the age group of 20 and 30. In 2018-19, 11 per cent of investors aged 20-30 traded in F&O. It increased to 36 per cent in 2021-22.

What is worrying is that on average, an individual trader lost Rs 82,500 in 2022, Value Research said.

Despite that F&O trading is lucrative for the stock market as well as stock brokers. Several stock broking firms have made as much as 80 per cent gains from F&O trading.

What Are Derivatives?

Derivatives are traded based on a predetermined rate. For example, a derivative on sugar is an agreement or contract where one party agrees to buy a certain amount of sugar (say) after six months of time, from the second party.

Once the contract is finalised, it is a full-fledged financial instrument that can be sold or bought on the stock exchange, just like any other financial asset. Deep and trusted expertise in a particular market (say, a metal like copper) is required to make money.

Value Research in its note said F&O pricing is often swayed not solely by fundamentals but by market frenzy and knee-jerk reactions. External elements like market sentiment, speculation, and sudden market reactions can contribute to occasional irrational price fluctuations in the derivatives market, more so than in the stock market, it said.

China’s Action

After a surge in derivative trading in China, the country's securities regulator has now announced heightened scrutiny of derivative businesses. The China Financial Futures Exchange (CFFEX) even acted against a Shanghai-based hedge fund for exceeding the limit when trading stock index futures. Derivative trading has surged in Asian markets, but in India, it grew the fastest, a Nikkei Asia report said.

An analyst said that the frenzy to make quick money in the post Covid pandemic phase is also driving many towards this highly risky segment.

Household Savings Patterns Impact The Economy

Indians have traditionally preferred parking their money in public financial institutions like PSU banks, small savings instruments, and post office branches—the money that created the bulwark for the bank credit structure while boosting the economy. However, data indicates they are now gradually moving towards real estate.

“An average Indian is no more risk averse, she wants to buy a house, own a vehicle and the chunk of the income is directed towards that,” the analyst said.

RBI data in September 2023, revealed that India's net household financial savings comprising bank savings, cash, and investments dropped to 5.1 per cent of the GDP in FY23. It was 7.1 per cent in 2020-21.

Naturally, the falling household financial savings have turned into a cause for concern for the government. During the global economic meltdown of 2008-09, India's high household savings rate had helped New Delhi tide over the crisis. However, in an era where interest rates on banks and small savings are being kept low to help prop up growth, how this will be done is a moot question.

Besides, policymakers feel, that a sudden dent in the derivative market could also severely damage investors’ confidence. And this is something the government does not want.

Trading in F&O has emerged as a lucrative option offering better and quicker returns on investments. But most investors are unaware of the risks and other downsides. F&O trading needs a proper understanding of risks and opportunities. “That is not the case with most of the investors,” Value Research’s Kumar said.

Regulatory and supervisory actions on derivative trading need to be adopted. Without effective regulatory supervision, Finance Ministry officials feel, that risky derivative trading driven by the urge to make quick money can trap the process of future capital formation in the Indian economy.

Among possible measures, being considered is mandating a floor limit for dealing in the F&O derivative segment so that the small retail investors, who have suffered the maximum loss are weeded out or at least kept out except for the determined few.