India’s options trade faces a less lucrative reset

MUMBAI, June 25 (Reuters Breakingviews) - India is moving to make stock trading less like a game, opens new tab. Officials are planning more stringent margin and disclosure rules in the country’s equity derivatives market, which has become the world’s largest by volume of trades. Tightening the screws should help protect small-time traders and pre-empt a wider bust, at the expense of slimmer winnings for trading firms like Jane Street and a new crop of discount brokers.

A pandemic-era influx of retail punters has driven turnover in Indian index options contracts to $135 billion in March, six times the level four years earlier. The ranks of active derivative traders have swelled to four million from less than half a million in 2019, Axis Bank’s mutual fund reported last year.

In terms of trade value, Mumbai’s National Stock Exchange lags more developed markets. It executes options trades worth a quarter of the United States, per an analysis by the Futures Industry Association. Nevertheless, the scale of its ravages is serious. The Securities and Exchange Board of India found that nine of 10 individuals trading in futures and options incurred losses during the 12 months to the end of March 2022.

It has become common for travellers on Mumbai’s suburban trains to exchange trading tips and for young people in far-flung locations to punt on shares and options as a perceived road to quick riches. The phenomenon has prompted India’s two bourses to propose a written test for moms and pops eager to trade in derivatives, local newspaper Mint reported, opens new tab in April.

Ironically, regulation is partly to blame. SEBI’s 2020 move to tighten margin norms for trading in cash equities helped lure punters into options. Another factor is the rise of brokers including Zerodha and the $3 billion Angel One, which charge a flat 20 rupees (24 cents) for each trade. That is about a fifth the fee a traditional brokerage charges for derivative contracts, the head of one firm told Breakingviews.

Zerodha and Angel One reported growth in net profit of 39% and 42% respectively for the year to the end of March 2023, a period when ICICI Bank’s $3 billion broking unit saw earnings fall. Foreigners are cashing in too. The India trade has proved lucrative for foreign investors, as Jane Street revealed when it sued rival Millennium Management and two former employees for using an India-focused options trading strategy.

Higher margins on derivatives should rein in retail investors, squeezing local brokers and big funds which benefit from large volumes. They may end up creating unforeseen risks, like the 2020 rules. That will hardly deter SEBI. Busts have a way of spreading rapidly through India’s financial system; a default by a large shadow bank in 2018 led to a wider credit squeeze. All the more reason to make derivatives trading less fun.

The Securities and Exchange Board of India is considering a series of tweaks to its derivative trading rules to address risks arising from explosive growth in options trading, Reuters reported on June 18, citing unnamed sources. The new rules could include higher margins for options contracts and more detailed disclosures, the report added.

On June 8, the markets regulator issued a consultation paper, proposing a review of eligibility criteria for stock derivatives.

Any unchecked explosion of retail trading could trigger challenges for investor sentiment and markets, India's finance minister Nirmala Sitharaman said on May 14.