Equity options boom: Retail frenzy a growing concern as “sachetisation” of option plans draws in younger investors from small towns

Last year, Indian investors traded 85 billion options contracts, more than anywhere else in the world, having overtaken the US in the volume of annual trades just before the pandemic.

That the Nifty 50, the NSE's benchmark index, has been hovering around its lifetime high has helped the options boom. (File)

A frenzied growth in India’s equity options market, which clocked a record 85 billion trades last year and accounted for 84 per cent of all equity option contracts traded in 2023, is unnerving policymakers and regulators. Apart from the investment surge, the worries for policymakers are twin pronged: that the most traded equity-index options in India are risky short-dated contracts and retail investors now make up over 35 per cent of options trades, undeterred by the fact that 9 out of 10 individual traders in the equity futures and options (F&O) segment are recorded to have incurred losses.

Designed originally as a tool for hedging risk, derivatives instruments such as can be options have traditionally played second fiddle to equities. Index options, for instance, are generally used to wager bets on the future direction of a benchmark index, such as the NSE, for a small fee. Equity-index options give the holder the right to buy an index at a specified price, called the strike price, when the contract expires at a future data. If the index were to climb higher than the strike when the contract expires, the holder makes money. Else, they lose the cost of the options, called the premium, which is generally a small amount. The problem, though, is that shorter dated contracts, which are clear favourites among Indian investors, are generally more risky. Plus, the investment flows coming in from the retail segment makes matters worse. The NSE is where most of the action is concentrated, which handles over 90 per cent of all equity options transactions.

That the Nifty 50, the NSE’s benchmark index, has been hovering around its lifetime high has helped the options boom. Not surprising that the Exchange, in a circular dated April 23, said that it is not considering imposing transaction charges for F&O contracts on Nifty Next 50 Index that was to be applicable since launch on April 24,2024. “In order to encourage active participants in Futures and Options contracts on Nifty Next 50 Index, it has been decided that no transaction charges will be levied on the trades done in Futures and Options contracts on Nifty Next 50 Index (NIFTYNXT50) in Future & Options segment from April 24, 2024 (product launch date) till October 31, 2024″, the NSE said in its circular.

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Last year, Indian investors traded 85 billion options contracts, more than anywhere else in the world, having overtaken the US in the volume of annual trades just before the pandemic. The exponential growth is evident in the numbers, Stock options contracts surging 138 per cent in turnover in three years and index options up 425 per cent. There are multiple enablers. A top CIO at a leading MF said that changes made to the contract structures over the last few years, alongside easier onboarding and interface of the new generation trading apps has triggered a “gamification of this market”. This, in tandem with what he called a “sachetisation” of options, has attracted a younger demographic as well as clients from Tier II and III cities. “There is a segment of people who are chasing futures and options, and they are unlikely to make money on a consistent basis,” Nilesh Shah, MD, Kotak Mahindra Asset Management Company, told The Indian Express in an interview.

Mumbai-based Upstox, a new age broking firm, is pitching ready-made options strategies as curated meal combos for the financial market while Bangalore-based Zerodha propounds option as an investor tool for “protecting your position and reducing risk” with the claim that “statistically, the option seller has a higher odd of winning in a typical option contract”. A band of so-called finfluencers are on an overdrive to lure investors to the risky and complex options trading. In India retail investors now make up 35 per cent of options trades, undeterred by the fact that 9 out of 10 individual traders — in the equity F&O segment incurred losses. And new age online brokerages promise to help investors “trade options like a pro using ready-made strategies” that involve what the brokerage claims are “ready-made option strategies”, described as “curated meal combos for the financial market”.

The issue of increasing retail investor exposure has been flagged at the level of the markets regulator and actively discussed by officials in North Block, where there are concerns about a build-up of a bubble, coming at a time when there is already some unease over the small and mid-cap investments by retail participants and another round of irrational crypto exuberance is anticipated.

While derivatives volumes now account for 5-15 times their cash market volumes in most western markets, it’s more than 400 times higher than that of underlying cash market today in India, a steep rise from three times in 2010, according to the top fund manager with a private fund house.

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“Change in contract structure, leverage combined with the ease of onboarding and interface of the new generation trading apps has triggered gamification of this market with number of active derivatives traders jumping 8 times to 4 million from less than 0.5 million in 2019,” he says. In comparison, in the cash market, the number has grown 3 times — from 3 million in 2019 to 11 million.

Though the NSE cautioned investors not to subscribe to any such scheme/product offered by any person offering indicative/ assured/ guaranteed returns in the stock market as the same is prohibited by law, investors are still being lured by false promises. Operators and broking firms encourage retail investors to build up options positions through Facebook, WhatsApp and Telegram channels, promising assured returns. Derivative trading – futures and options – in the stock market is clearly not for individual traders, if a study by the Securities and Exchange Board of India (Sebi) is any indication.

As many as 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 FY22, Sebi warned in the study. Further, 90 per cent of the active traders incurred average losses of Rs 1.25 lakh during the same period, the regulator cautioned. According to the Sebi, for the group of active traders (excluding outliers), on an average, loss makers registered net trading loss close to Rs 50,000 in FY22. For the group of active traders (excluding outliers), the average loss of a loss maker was over 15 times the average profit by a profit maker during FY22.

E.DOT

While options trading, a form of a derivative contract that gives buyers of the contracts (the option holders) the right (but not the obligation) to buy or sell a stock or index at a predetermined price at some point in the future, is generally seen as safer form of investment where upside risks are capped, the complexity of derivative instruments such as options and futures make it somewhat unsuitable for general retail investment.

Anil Sasi

Anil Sasi is National Business Editor with the Indian Express and writes on business and finance issues. He has worked with The Hindu Business Line and Business Standard and is an alumnus of Delhi University. ... Read More

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