Options trading has seen a spectacular rise in India and so have retail losses while trading them. While no two markets are alike, experiences from other countries suggest the key role of regulators in restraining speculative retail trading. The potential course of actions include (1) regulatory overhaul through a qualified investor regime, (2) increasing entry barriers (lot sizes), (3) higher regulatory taxes/charges, (4) a crackdown on influencers (already underway) and (5) rolling back weekly expiries.
Retail options trading losses on the rise; potential options for consideration
With the sharp rise in retail share of premium turnover over the past few years, we estimate option trading losses to have increased as well. This is based on a simple extrapolation of the growth in retail premiums and loss rates implied by the SEBI report (covering 2019/2022 data). Losses are likely to be skewed (similar to SEBI's 2022 findings), given that ~20% retail traders are likely to contribute ~90% of retail trading volumes. Few examples of actions undertaken by regulators in other markets, when faced with high growth in retail derivatives trading, include: (1) regulatory overhaul through a qualified investor regime (2) increasing entry barriers (lot sizes), (3) higher regulatory taxes/charges, (4) a crackdown on influencers (already underway) and (5) rolling back weekly expiries (still a new phenomenon; no regulatory precedence yet).
Global experiences and learnings
We discuss a few case studies of strong and often sudden growth in retail participation across countries such as India, the US, Korea and China. The key learning is that onerous regulations are easier to implement post-facto, whereas regulating in anticipation and determining product suitability is the tricky part. Both China and Korea have seen retail trading booms that ended with onerous regulations in response. The US is going through a few similar challenges as India, leading to consultations (and enforcement actions) regarding the level of duty to be placed on self-directed apps and to minimize harm for retail traders.
In India's case, the SEBI has implemented various impactful measures (such as peak margin rules, segregation of collateral and upstreaming of client funds), which resulted in a robust market infrastructure and securities ecosystem. However, safeguarding retail against inordinate risks in F&O markets, while not stifling access to well-regulated products, is likely to be the next trade-off.
India's love for options has few underlying drivers
The rise in retail trading in India post-Covid is well-flagged and owes its fair share of credit to the robustness of India's market and digital infrastructure. Growth in options trading is even more exceptional. Several factors could potentially explain this rise-(1) options provide the cheapest leverage of all products, (2) the introduction of new products with weekly expiries, (3) margin rules have pushed more volume toward options and (4) ease of account opening and low entry barriers for traders. |
