Options trading is a way of dealing in contracts that give the buyer the right, but not the obligation, to buy (call option) or sell (put option) a particular asset (like a stock) at a certain price by a certain time. It’s a bet on the future price movement of the asset.
Markets regulator SEBI is looking at ways to make sure options trading is done responsibly and to protect investors from excessive risks.
SEBI is concerned about the recent surge in options trading, particularly by retail investors, for a couple of reasons like;
- Higher Risk: Options trading can be much riskier than standard stock purchases. Options contracts have a time limit, and if the price doesn’t move in your favour by the expiry date, you lose your entire investment. This can be especially dangerous for new investors who might not fully understand the risks involved.
- Potential for Market Manipulation: A large volume of options trading on a specific stock could create artificial price movements and volatility, potentially harming the overall market stability.
Why Options Trading In Radar? What’s the Latest Update?
According to a recent report by Reuters, SEBI is considering a series of tweaks to its derivative trading rules, as it seeks to address risks arising from explosive growth in options trading.
The report added that the new rules could include higher margins for options contracts and more detailed disclosures, and are being considered after a series of meetings with exchanges, brokers and fund houses over the past four months, the sources told the news agency.
Trading in index and stock options has soared in India in the last few years, fueled mainly by retail investors, sparking warnings from market participants and government officials.
The notional value of index options traded more than doubled in 2023-24 to $907.09 trillion from the year before.
An unchecked explosion in retail trading of futures and options can create future challenges not just for the markets, but for investor sentiment and household finances, India’s federal finance minister warned last month.
One source who is a regulatory official told Reuters that there was a need for appropriate risk disclosure and steps to prevent excessive speculation or possible manipulation.
The first step the regulator is considering is a linking of options trading with underlying cash volumes in a stock, to contain the build-up of open positions in less liquid stocks, the sources said.
In cases where there is excessive build-up of options positions relative to cash volumes, the margin requirement for trading options would increase, they said.
Options volumes in India are roughly four-fold underlying cash trading volumes, whereas the global average ranges from 5-15 times.
“This ratio has raised concerns,” said the second source.
In the United States, the derivatives to cash ratio is about 9 times.
SEBI will also suggest increasing disclosures on index and stock options contracts, rather than just options activity and open interest as is now done, the sources said.
The regulator is planning to ask exchanges to levy flat fees on brokers regardless of their turnover, the sources said, changing a practice of charging lower transaction fees for brokers with high turnover.
Earlier this month, SEBI suggested tighter rules for individual stock derivatives which, if implemented, would weed out derivatives linked to illiquid stocks.
The proposed changes are in the discussion stage and will be put up for public consultation over the next few months before they are introduced, the sources said.
RISING SPECULATION?
Of the 108 billion options contracts traded worldwide in 2023, 78% were on Indian exchanges, according to data from the Futures Industry Association(FIA). Retail investors make up 35% of derivative trading in the country.
In April, 78% of trades done on India’s largest exchange, the National Stock Exchange were by investors trading less than 1 million rupees ($11,969).
The burst of volumes has created an opportunity for foreign trading firms.
U.S.-based Jane Street and Millennium are currently in a legal fight in courts with the former suing the latter for its India options strategy. Jane Street claimed it earned about $1 billion in revenues from the strategy in 2023.
As yet, Indian exchanges haven’t launched zero-day expiry options contracts, a popular strategy involving buying an option contract the same day it is set to expire, which helps traders mimic similar contracts offered in markets like the United States.
A source familiar with the government’s thinking said that in private conversations, officials have expressed its reservations about a surge in zero-day options trading.
This is pure speculation and doesn’t serve any purpose in the market, the source said.
The government has also asked the regulator to consider if lot sizes of options contracts can be increased to prevent very small investors from entering the market, this person said.
An email sent to India’s finance ministry on Friday seeking comments has not been answered.
The rate of growth of options volumes in India is explosive and much higher than anywhere else in the world, Will Acworth, Senior Vice President, Data & Research, FIA said.
“The real issue for the government and SEBI is less about risks to the financial systems but more about investor protection,” said Acworth, adding that buying options without fully understanding the product is akin to gambling.
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