It is called fatal attraction. A bug is attracted to a light source even though it could be the death of it. Among humans, it is often the thrill of doing something dangerous. For instance, some people indulge in death-defying stunts; some undertake perilous expeditions; some have addictions that are injurious to health; and some gamble away their financial future.
What else explains the fact that there has been no let-up in the popularity of Futures & Options (F&O) trading in India despite investors being met with a blunt warning when they log into their trading accounts? The warning goes: “90% of people are making losses in Futures & Options trading. The average loss is Rs 50,000 per client.” It is reminiscent of the health advisories on cigarette packs. And like cigarettes, F&O trading can be addictive, when investors, like smokers, disregard the warning, which could lead to financial ruin.
Speculators, mostly youngsters, make a beeline for the risky world of F&Os, lured by the promise of hitting the jackpot. This has led to the F&O market ballooning in recent years, with annual turnover surging from Rs 1,695 lakh crore in FY22 to Rs 79,927 lakh crore in FY24.
What are F&O contracts? F&Os in the share market are contracts that derive their price from underlying assets such as shares and market indices. The contracts are signed by two parties for trading a stock asset at a predetermined price on a later date. Such contracts try to hedge market risks by locking in the price beforehand. While a futures contract to buy/sell underlying security has to be followed up on the predetermined date at the contractual price, an options contract provides a buyer with a choice to do so, if he/she profits from a trade. An options contract can be of two types: a call contract, and a put contract. Usually, a trader goes in for the put option when they expect the price to decline; traders go in for a call option when they expect prices to go up. An options buyer has the right to enforce the contract while the seller has the obligation to execute it.
For instance, if you buy a weekly Nifty index call option with a lot size of 50 shares, betting that the index will rise from its current level or strike price of 24,000 points to 25,000 points, the seller may offer a premium of just Rs 200 per share for this call option. The total cost will be Rs 10,000 (50 x Rs 200). If the index does not reach the target of 25,000 points by the expiry date (seven days later), you, as the options buyer, would lose a maximum of Rs 10,000 as premium. However, if the index does reach 25,000 points, the premium will be, let us say, around Rs 600 a share. Then the buyer stands to make a profit of 200%, or Rs 20,000.
The surge in F&O volumes is a post-Covid phenomenon, driven by new investors. Of the 150 million investors in the country, 120 million have entered the market in the past three years, according to data from the Securities and Exchange Board of India (Sebi). The F&O market’s low entry costs, high leverage, and potential for significant returns have made it highly attractive to newcomers. This is amplified by discount brokerage firms, new-age trading platforms, and investment advice offered on social media like YouTube, WhatsApp, and Telegram—either for free or for a subscription fee.
The sheer scale of the F&O market—it is 368 times the volume of the cash market and nearly 245 times the country’s projected nominal GDP of Rs 326 lakh crore in FY25—has set off alarm bells. This rapid growth is a reminder of past financial bubbles, such as the 2008 global financial crisis, triggered by mortgage derivatives. And that is making the government, regulators, and exchanges jittery. This has led to the government levying additional taxes on F&O trades that come into effect from October 1, and Sebi planning more regulations to make F&O trading inaccessible for small investors.
Market regulators, stock exchanges, and brokers have all contributed to making F&Os attractive to investors, with the government collecting Rs 60,000 crore annually from taxes. Why the crackdown on F&Os then?
The Economic Survey 2023-24 points to the gambling instinct of retail investors. “Derivatives trading holds the potential for outsized gains. Thus, it caters to humans’ gambling instincts,” it states. And that is a perception the stock market does not want to create, says Gurpreet Sidana, CEO of Religare Broking Ltd. The options market is complex, requiring knowledge of risk terminologies and pricing models.
“Unfortunately, many retail investors may find it difficult to grasp how the mechanics of the F&O market work,” says Vaibhav Sanghavi, CEO of ASK Hedge Solutions. Sebi is also troubled by the fact that retail investors have lost Rs 52,000 crore in F&O activity during FY24. Market players suggest that high-frequency algorithmic traders and foreign investors are profiting significantly at the cost of retail investors—a point that Sebi also makes. A deeper analysis of NSE data shows that more than half of the trading value on options (index and stock options) comes from co-location that are mostly proprietary trades done by domestic and foreign brokerages. Co-location, which grants certain brokers preferential access, is another concern listed by market participants.
There are other reasons, too. Many retail investors do not follow the rule book and take naked positions without any hedging, say experts. In F&O, taking a naked position means selling a contract without having the underlying asset. “It is important to follow a strict stop-loss policy,” says Atul Parakh, CEO at Bigul, the digital investment platform of Bonanza Portfolio Ltd. Stop-loss refers to a limit set on trades to minimise losses. Experts recall that after the 2008 meltdown, it took at least a decade for people to realise that the stock markets are not a place to lose money. The government’s concern is the likely loss of confidence in the stock markets and its implications in the case of a black swan event or bear phase.
At a BSE event in Mumbai in May, Finance Minister Nirmala Sitharaman had said that any unchecked explosion in retail trading in the F&O market “can create future challenges for the market, investor sentiment, and household finances”. Sebi Chairperson Madhabi Puri Buch, at an NSE event in Mumbai in late July, had also highlighted the significant financial losses households face in the F&O segment, estimating annual losses of up to Rs 60,000 crore. This, she had argued, was not just a micro-level concern but a macro-level issue with potential implications for the broader economy. Sebi is working closely with banking regulator, the Reserve Bank of India, to tackle this issue.
But not all investors in the options trade are retail investors, say experts. “The risk is for a sell-side investor in an options trade, as buy-side investors have risk limited to the premium,” says Siddarth Bhamre, Head of Research at Asit C Mehta Investment Intermediates. Most options sellers are sophisticated investors with capital.
Sebi’s whole-time member Ananth Narayan points to traders treating expiry day trading as playing in a casino for the jackpot. Usually, options premium reduces as expiry nears. “It would be unfair to compare all of equity F&O with a casino and lose sight of its utility in capital formation. That’s not what we are saying. We are talking only about the specific portions of trading closer to expiry,” he said recently.
Market experts blame exchanges and brokerages for steering individual traders away from the cash market over the past decade, pushing them to futures, options, and finally to index options. This happened because of increased margins for the cash segment and reduced leverage in the cash and futures markets. “Initial adopters attracted subsequent participants as volume and liquidity grew,” says Jimeet Modi, Founder of Samco Securities. “Options eventually became the market’s most liquid segment, naturally drawing liquidity-seeking traders.”
The introduction of weekly contracts in 2018, in addition to monthly contracts, further amplified trading volumes. As a result, the market share of index options, which was less than 5% four years ago, is now close to 30% of F&O turnover (see graphic ‘Decoding the F&O Juggernaut’).
“Exchanges have also promoted this segment as a speculative platform,” admits an exchange official on condition of anonymity. Plus, Sebi allowed exchanges to launch different weekly index options on separate days. “If it is a perceived risk, it should not have been allowed,” says another market player. Religare’s Sidana says over time it has been observed that instead of using F&O for hedging, “people are taking naked positions without any hedging”.
Let us examine F&O trades in detail to bust a few common myths. “The total number of monthly investors who trade in F&O in the retail category is not more than 3.5-4 million,” says Samco’s Modi. Compared to that, the corresponding number in the cash market is 12.5-15 million, he says. According to Rishi Kohli, Managing Partner & CIO-Hedge Fund Strategies at InCred Capital, 80-90% of the activity in index options (in terms of value) is driven by large, sophisticated players. “While the retail segment appears substantial in terms of numbers, its contribution is likely in the 10-20% range,” he says.
Second, a large portion of retail activity under index options involves buying options, with the risk limited to the option premium. Since the option seller carries the risk, there is a systematic way of covering SPAN (Standard Portfolio Analysis of Risk) margins and other exposure margins. “Normally, SPAN margins are calculated on three sigma, but in the Indian market, it is calculated on six sigma. So, it covers a much higher possibility of risk,” says Shiv Kumar Goel, Director at Bonanza Group. Six sigma accounts for extreme market volatility and requires traders to keep more capital in reserve to cover potential high margins and trading losses.
The bigger issue is of options sellers engaged in selling naked options. “This selling activity is a genuine concern, but it constitutes only about 10-20% of retail activity. The remaining 80-90% of retail activity involves buying options, where risk is limited to the premium paid,” says Kohli.
Market experts also raise questions about Sebi’s study that found that 9 out of every 10 trades result in losses for investors. “It’s very difficult to dissect which participant enters the options market with what objective—hedging, speculation etc.,” says Sanghavi of ASK.
“Whether I am a retail investor or a big investor, Sebi cannot take away my right to hedge my portfolio,” says Bhamre. Experts suggest that hedging constitutes a negligible portion of the total trading activity. Most of the trading volume comes from Nifty and Bank Nifty options contracts. Investors who hedge in these indices should have a portfolio representing Nifty or Bank Nifty, which would typically be worth at least Rs 40-50 lakh, they say.
Then there is the issue of notional turnover. “The exchange reports the notional value,” says Modi. For instance, if a trader buys a lot of 25 shares of a Rs 25,000 call option at a premium of Rs 1.25 for a weekly expiry today, this will be treated as having a notional value of Rs 6.25 lakh (25 x Rs 25,000), while the actual cost is only Rs 31.25 (25 x Rs 1.25), explains Modi (see box ‘F&O Leaves Cash Behind’).
Third, algo trading is also driving significant trading volumes as a single algo could execute trades equivalent to those of 100,000 investors. A Sebi consultation paper observes that larger non-individual players that are high frequency algo-based proprietary traders or foreign investors, are, in general making offsetting profits, where gains from some trades make up for losses in others.
Finally, some market experts say that the argument that the F&O segment is responsible for the decline in household savings and bank deposits doesn’t hold water. Manoranjan Sharma, Chief Economist at Infomerics Ratings, says perhaps a much more important factor is the influx of money in the stock markets via the SIP route (Rs 25,000 crore a month) by mutual funds. “There are also factors like higher returns in other asset classes, such as, gold and real estate and the high rate of inflation,” he says.
How does one keep F&O risks in check? “The volume of F&O trading in Indian markets has become practically unsustainable, unmanageable and unnecessary for the healthy functioning of the stock markets,” says Religare’s Sidana. Sebi is now working on several proposals to check speculation (see box ‘Reining in F&O’). Securities transaction tax (STT) is currently levied on the premium in options contracts, while futures contracts are taxed on the entire notional value. Currently, options sellers aren’t subject to daily mark-to-market (MTM) adjustments until they unwind the position. This creates a disparity compared to futures contracts, where daily MTM applies, leading to lower volumes in the futures market. “If reducing retail participation is the goal, increasing the lot size could be effective. Higher margins would be required for selling options, raising the entry requirement,” says Bonanza’s Goel. Will increasing the lot size work? “Retail investors who deal in a lower number of lots, will have to compulsorily do one [proposed higher] lot, which eventually will lead to higher turnover,” says Sanghavi.
Experts suggest imposing certain fixed conditions on the net worth of the client. “We rely on self-declared income, which isn’t verified. Requiring documents like net worth certificates or ITR copies, needing CA certification, would increase costs and discomfort for clients,” says Bigul’s Parakh. Another issue is investor education. In Singapore, investors undergo a Customer Knowledge Assessment (CKA), while in the UK, regulators require customer-level certification through mandatory training and exams, especially for high-risk products. On its part, Sebi is also planning to ease regulations to encourage more registered investment advisors.
Similarly, any manipulation or unequal access to brokers at the exchange level should be looked into. Co-location has contributed to rising volumes as brokers house their servers on exchange premises.
Experts say regulations related to F&O trades will have to tread a fine line to ensure investors don’t find them too restrictive. Sebi’s proposed measures, if implemented, will have an impact on liquidity. “Building liquidity in a contract is a gradual process. Once built, if liquidity is disrupted, it is very challenging to rebuild,” says Goel. In 2014, South Korea raised minimum deposits for F&O trading to protect retail investors, leading to a significant drop in volumes. “By curbing trading, you will actually give rise to larger risks. The lack of liquidity causes systemic risk,” warns Modi. If there is a higher threshold, retail investors may be unable to enter the market for hedging. Kohli reasons that if that happens, then market makers also reduce their activity, which can unintentionally affect the cash equity market as well. “Suddenly, impact costs might increase, and even long-only, long-term funds might see reduced returns or lower activity due to the increased market impact,” he explains.
In a social media post on X, Zerodha’s Founder and Chief Executive Officer Nithin Kamath said that the suggested changes, even with the increase in STT, won’t change options volumes. “But on the flip side, they will reduce futures volumes,” he posted.
Currently, NSE is the leader in the F&O market. The proposal for one weekly contract per week per exchange is likely to push volumes to BSE and GIFT City. Experts say these volumes could also shift to stock options.
Finally, the government gets Rs 60,000 crore-plus in annual tax, with zero cost of collection, zero leakage, zero non-compliance, and zero administrative cost. “It is almost 2.5% of direct tax collections,” says Modi. Experts say the government is unlikely to impose restrictions that could harm tax revenues.
Experts suggest that India aims to be a developed country, and resources, capital and development will come with free markets, not constrained ones. “The more you constrain, the less likely you are to become a developed nation,” reasons Modi. The task of taming the F&O menace is not only in the hands of authorities and market bodies, but also with those retail traders who have not experienced the market’s harsh realities yet. Much like how addiction drives the cigarette industry, the F&O menace needs to be understood by investors.
“We as stockbrokers, exchanges, or regulators are not supposed to be in the business of managing an individual’s greed and fear. All we can do is make aggressive awareness about the risk in the product,” advises Modi. Clearly, the dangers of ignoring warnings and lacking self-control are substantial. The ball is now in Sebi’s court.
