A growing army of retail investors in India is flocking to the futures and options (F&O) segment of the stock market. Recent increase in retail investors’ participation in this segment without knowing much nuances, paints a worrying picture. An analysis by a leading financial research firm reveals that the total average daily turnover in the segment was ₹329 trillion in October 2023, up 130 per cent from the same month last year, at ₹143 trillion.

While the allure of quick profits and leverage might be tempting, the market regulator is also worried about the exponential growth of retail traders in the F&O category, which is regarded as dangerous and frequently loss-making.

So, why does this happen? Inspired by market pundits touting ‘multibaggers’ and F&O’s ‘get rich quick with less investment’ potential, investors anchor their expectations to these outliers. They ignore the 89 per cent who lose money (SEBI, 2023), focusing instead on the 11 per cent who win often due to near perfect estimation of associated risks. This optimism bias then fuels overconfidence, leading investors to underestimate the complexity and risks involved.

Further, the endowment effect kicks in. Once they have entered the F&O arena, investors feel a sense of ownership and attachment to their positions, even if they are losing money. This sunk cost fallacy prevents them from cutting their losses and exiting. They keep hoping for a turnaround, throwing good money after bad. After a string of losses, investors convince themselves that the next trade has to be a win. This ‘streak’ mentality ignores the randomness of market movements, leading to more irrational bets in a desperate attempt to break even.

A survival guide

The F&O segment can be a thrilling arena, but for the unprepared, it is akin to crossing a bridge made of glass. While the potential for amplified gains exists, so does the risk of devastating losses. Here are some vital points for retail investors to consider before venturing into the F&O world. Do not underestimate the complexity of options and futures. Thoroughly understand the market mechanics, pricing models, greeks (delta, gamma, theta, vega), and the impact of volatility. Treat it like an academic pursuit, not a casual dip in the market.

Leverage in F&O is a double-edged sword. While it can magnify profits, it can also exponentially amplify losses. One should develop a robust risk management framework, using stop-loss orders, position sizing strategies, and margin monitoring tools. F&O trading is prone to emotional rollercoasters. Fear can lead to premature exits, while greed can trap you in losing positions. Investors need to cultivate emotional discipline, stick to the trading plan, and avoid impulsive decisions. Understand the risk-reward dynamics of each trade, calculate potential losses before profits, and don’t chase hot tips or market rumours. Furthermore, aim for consistent, sustainable returns, not overnight riches.

F&O success stories are often anomalies, not the norm. Focus on small, incremental gains and avoid the lure of ‘get rich quick’ schemes. The F&O market is a professional playground. Be aware of institutional players with superior information and resources. Finally, know when to walk away, because sometimes, the wisest decision is to fold your hand.

A study by SEBI (January 25, 2023) revealed that only 1 in 10 individual traders actually profits, the rest averaging losses of ₹1.1 lakh. These are not odds most retail investors can afford to play. So, what should retail investors do? Stay away from F&O unless you possess the expertise and risk tolerance that of seasoned professionals. Instead, focus on long-term wealth creation through diversified equity investments, where time becomes your friend and emotions do not cloud judgment.

Saravanan is a professor of finance and accounting at IIM Tiruchirappalli, and Williams is an analyst at Sernova Financial

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