News Analysis

Surging turnover in stock futures and options a warning sign

Gurumurthy K BL Research Bureau | Updated on January 11, 2018

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Volumes in these segments typically spike in the final stage of an up-cycle

With indices hitting record highs, investors and traders have flocked to the stock market in droves. It is, therefore, not surprising that the turnover on stock exchanges has also spiked in recent times.

However, the point of concern is the increasing interest in stock futures and options. It implies that retail investors, who do not have sufficient risk-taking ability, are increasing their activity in the derivative segment. Total monthly derivative turnover on the NSE has increased from ₹54 lakh crore in April 2016 to ₹118 lakh crore in July this year, an increase of 120 per cent. This growth is much higher than the growth in the cash segment, which increased 67 per cent during this period.

Within derivatives, the monthly turnover in the stock futures segment has surged 82 per cent from ₹6.47 lakh crore in April 2016 to ₹11.83 lakh crore in July 2017. The turnover on the stock options has more than doubled over the same period from ₹3.22 lakh crore to ₹7.62 lakh crore, at 136 per cent.

Signs of over-heating

Interest in stock futures and options typically increases close to market highs. This is because the more vulnerable section of investors, who do not understand the risk, start trading in stocks in the latter part of a market up-cycle. Take, for instance, the last stage of the previous bull market, in 2007. Turnover in stock futures and options had more than doubled between December 2006 and December 2007. Turnover in stock futures went up from ₹3.48 lakh crore to ₹8.5 lakh crore and in options from ₹16.4 lakh crore to ₹33.7 lakh crore.

Stock futures carry a higher risk and many small traders suffered huge losses in the market crash of 2008 due to high exposure to this segment. While the loss is limited to the premium paid in stock options, traders are faced with unlimited losses in stock futures.

The regulator too thinks that retail investors are taking undue risks without being aware about the consequences.

A recent discussion paper on growth and development of the equity derivatives market in India, put out by market regulator SEBI, shows that retail investors form the second-largest category of participants in the equity derivative segment, accounting for 25.67 per cent of the total turnover in 2016-17. These investors are active in stock futures, index futures and stock options.

According to the report: “Indian market does not have the concept of product suitability framework. Investors may not have adequate understanding and financial capability to withstand risk posed by complex derivative.”

The regulator is of the opinion that sales practices and disclosures for derivatives need greater supervision.

Chasing higher returns

Some experts think that the appetite for higher returns has increased investor interest in the stocks segment as against the broader index segment.

“In an environment with a highly positive sentiment, retail and high-net-worth participants would be attracted more towards stocks because individual stocks usually perform well when compared to the index,” says Sahaj Agrawal, DVP-Derivatives, Kotak Securities.

The broader Nifty 50 index has risen 27 per cent since April 2016 whereas major stocks within the Nifty 50, such as Vedanta, Hindalco Industries and Maruti Suzuki India, have skyrocketed by 100 to 165 per cent over the same period.

Other stocks, such as YES Bank, Indian Oil Corporation, Tata Steel, HDFC Bank, State Bank of India and Reliance Industries have risen between 50 per cent and 95 per cent since April 2016.

Another reason for this growing interest in equities has been the increase in liquidity in the economy, say market participants.

Says Nithin Kamath, Founder, CEO, Zerodha: “There was more liquidity in the system after demonetisation. So, people started chasing assets that could give better returns, which, at that point of time, was stocks.”

Published on July 30, 2017

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