Role of SEBI in Educating Investors and Regulating Derivatives: Finding the Right Balance
Chairperson Madhabi Puri Buch of Sebi expressed concern about the increased participation of retail investors in equity-derivatives trading during the recent quarterly board meeting. While acknowledging that cautioning investors is the regulator’s responsibility, Sebi stated that they were not worried about systemic risks. In this article, we will explore the surge in derivatives volumes and retail participation in the equity F&O segment, analyze the benefits and risks of derivatives, and discuss the need for a balanced approach in Sebi’s regulation.
The Surge in Derivatives Trading and Retail Participation
Derivatives trading has witnessed significant growth, with the average daily turnover in the F&O segment reaching ₹331 trillion between January 1, 2023, and November 25, 2023. This represents a staggering 115% increase compared to the previous year. It is worth noting that the reported turnover is based on nominal contract value and leverage in derivatives is high. While this volume may seem impressive, it is crucial to consider the risks associated with such high leverage. Over 4 million individual investors have participated in the F&O segment.
The Dominance of F&O in Trading Volumes
F&O volumes currently account for over 99.5% of all trading volumes on the stock exchanges. The growth rate of F&O volumes between FY19 and FY24 has been remarkable, increasing 34 times. Retail participation has also surged, growing eightfold from less than five lakh in FY19. In comparison, the cash equity segment’s average daily volume stands at around ₹77,000 crore, representing a 110% increase since FY19. There are around 11-12 million direct retail equity investors, and assuming overlap, approximately one-third of them participate in the F&O market.
The Challenges Faced by F&O Traders
A Sebi report from January 2023 revealed that 9 out of 10 F&O traders experience losses, with an average loss of ₹56,000 per capita. The report highlighted that 90% of participants collectively lost around ₹45,000 crore, while the remaining 10% earned ₹6,900 crore.
Understanding the Role of Derivatives
Derivatives provide savvy investors with a means to hedge various risks. While speculators aiming to make quick profits contribute to significant trading volumes, their participation also enhances market efficiency by generating liquidity. This liquidity leads to lower premiums on options and faster trade execution.
Commodity, Forex, Interest, and Political Risk Hedging
Stock and Index F&Os offer opportunities to hedge against commodity risks, forex risks, interest risks, as well as political and geopolitical risks. Investors with significant equity exposure or exposure to specific assets can utilize these instruments to limit potential losses or even generate profits in specific situations.
Flexibility and Options for Investors
The availability of options on multiple stock indices allows Indian investors to hedge a wide range of events. For instance, a well-diversified equity portfolio holder might choose to take a put option in the Nifty Index to protect their portfolio from potential downturns. Similarly, long-term investors with substantial exposure to specific stocks can hedge their positions by taking the opposite position in the futures market.
Exploiting Known Unknowns and Political Risks
Investors can also use options to capitalize on “known unknowns” in the financial markets. During significant events like the Budget week or the RBI’s Monetary Policy Committee meetings, investors can speculate on likely policy decisions and take suitable positions in the Nifty or BankNifty, which is sensitive to monetary policy changes. Additionally, political risks, such as elections, can lead to increased volatility, making derivatives attractive to investors during those periods.
Striking the Right Balance: Responsible Regulation and Education
While caution is necessary, over-regulation or banning derivatives outright would be detrimental to the market. As long as no systemic risks arise, Sebi should allow the market to continue operating. Speculators, despite the potential for large gains or losses, serve an important purpose by enhancing liquidity, which benefits hedgers. Sebi can conduct educational campaigns to raise awareness among retail traders about the risks associated with derivatives. Raising margins, thereby reducing leverage, can also discourage excessive speculation.
By striking a balance between educating investors and ensuring responsible regulation, Sebi can support the continued growth and efficiency of the derivatives market.
Disclaimer:
Estabizz Fintech compiled the material in this article using the most recent Acts, Rules, Circulars, Notifications, Provisions, Press Releases, and material applicable at the time. They ensured the completeness and correctness of the material through due diligence. When using this material, users must consult the relevant, applicable legislation. The given data may change without prior notice and does not constitute professional advice. Estabizz Fintech disclaims all liability for any results from the use of this material.
