The monstrous growth of the derivatives segment

Lokeshwarri SK | Updated on January 27, 2019

Unhealthy levels of trading in derivatives is exposing retail investors to higher risks, says SEBI

The Indian stock-market regulator has done a laudable job of developing the trading ecosystem over the last 25 years. But one area where regulations have been ineffective is in checking the unbridled growth of the equity futures and options segment.

The Indian stock market has always been a big draw for speculators, earning it the name of satta bazaar (speculative market). This is probably why most ‘respectable’ citizens steered clear of stock markets prior to the ’90s, when stock trading was considered equivalent to gambling. While speculating is common in the cash segment, too, it is particularly the derivatives segment — which allows large positions with fairly small margins — where traders throng.

Before the introduction of futures and options in 2000, equity derivatives trading took place through the badla trading system where traders could carry forward the stocks purchased by paying an interest to the stock exchange. The non-transparent system and the excessive leverage it provided resulted in a series of payment crises in the ’90s, and was one of the causes of the 1992 scam.

The badla system was finally banned and Nifty-based index futures were introduced in June 2000; trading in index options followed a year later. The NSE was also the first global exchange to launch trading in futures and options on single securities in 2001. Investors accustomed to trading in the badla system found stock futures a close alternative and, therefore, it is not surprising that the NSE became one of the leading global exchange for trading in stock and index futures by 2007.

The sub-prime crisis resulted in investors losing heavily in stock futures, where loss is unlimited, unlike options. Thereafter, the scale tilted towards options, with trading in Nifty options accounting for more than 80 per cent of derivatives trading until a couple of years ago. Currently, trading in bank Nifty options have become more popular, relegating Nifty derivatives to the second place.

The sharp growth in the derivatives segment has, however, skewed trading in its favour, compared with the turnover in the cash segment. The daily average turnover in the derivatives segment in FY19 was around ₹10 lakh crore compared with the ₹35,000-crore turnover in the cash segment. The derivates-to-cash turnover ratio of 28 times is among the highest globally. This unhealthy level of trading in derivatives is exposing retail investors to higher risk, according to a SEBI report.

While the move towards physical settlement of stock derivatives could somewhat help check speculation, more needs to be done.

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Published on January 27, 2019
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