Retail participation in F&Os has ballooned recently, with option volumes spiking considerably since the introduction of “weekly” expiries (they used to be once a month earlier). Also, a Sebi study showed that over 90% of retail investors lost money in the derivatives market.
Exchange data reveals that retail investors account for 34% of all option premium turnover, with India becoming the world’s largest options trading market by number of contracts traded.
Anecdotally, people borrow money to trade options, driven by “get rich quick” videos on social media that promise even small traders life-altering wealth through options, if they follow a strategy and pay a small fee.
Given this context, does it make sense to curtail retail trading in options? And will these measures change anything meaningfully?
I have two thoughts. First, the derivatives market has a layer of systemic risk, as the exchanges stand guarantee for settlement. Indeed, they maintain a large amount as margins (roughly 10% of notional size), and have a little bit of their own capital as a guarantee fund. But with options trading hitting premium turnover levels of about ₹50,000 crores a day with a notional value to premium ratio of 500+, a really big black swan move (10% lower or upper circuit) could easily wipe out the margin of many option sellers.
Retail traders and larger players also sell options in large quantities, and the systemic risk of extreme blow-ups increases with higher option participation.
Second, retail investors don’t really need “protection” from overtrading. We should educate them, but beyond that, acting like a big brother by refusing people the opportunity in a fair market, is plain wrong.
The markets are not gambling dens or “dabba” centers, where the game is rigged against you. The markets are where you can build odds in your favour, and there are many traders that started really small and grew to become rich.
The low rate of success exists in every large opportunity – from exams for IIT seats, to startups and kirana shops, the failure rate is ridiculously high, but it would be a travesty if we disallowed people from these opportunities because of that.
We don’t need our people to be hand-held at every step, and if you look carefully, not many retail investors are complaining; it’s the larger, more established players, and that has included me. Are we being overprotective?
Enhancing market stability
That said, increasing lot sizes or bumping up margins might be a good idea to reduce the impact of the systemic risk that the burgeoning market involves. Value-at-risk (VAR) is used to calculate margins, but it’s a mathematical slave of the recent past, which hasn’t seen much volatility.
If volatility goes up slowly, VAR works. If it’s “quantum”, i.e. jumps up very sharply and suddenly, there won’t be enough time for traders to react, until circuits are hit and no further reaction is possible.
This happened in 2009, when markets went up way too fast, a 20% market circuit was reached, and trading halted for the day – in today’s times, a repeat of that event could trigger substantially larger losses. Higher margins or higher lot sizes keeps player capital reasonably high.
Reducing the number of expiries in the week reduces the “zero-days-to-expiry” (0DTE) rush, which creates incredible open-interest intraday, building more systemic risk. This might still help keep the system stable while not disallowing players from trading at all.
Yet, I don’t worry about retail participation being too much, per se. Even in 2003, retail investors were 37% of the option premium turnover–not much different from today.
India’s been a retail dominated market for over 20 years. Importantly, in recent times, retail investors have protected our markets from steep falls, even as foreign investors exited in droves after the Ukraine war. And in the sense that the market has risen substantially, they have won their profits.
We shouldn’t write them off as uninformed traders; that is an elitist argument. Instead, we should strive to keep systemic risk down and increase oversight within the system.
Deepak Shenoy is founder and CEO, Capitalmind, a SEBI-registered portfolio manager. Views are personal.
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