For retail investors, F&O trades are no longer a no-no

Mumbai: Small investors are increasingly getting more adventurous and savvier in the stock market. These market participants, who mostly bought shares to make a quick buck till recently, are increasingly punting on the market through the riskier futures and options even as the government and regulators attempt to dissuade retail participation in such products.

Retail investors embraced the derivatives market in a big way during 2018. The average daily turnover of retail investors has nearly doubled to Rs 9 lakh crore from Rs 4.7 lakh crore during 2017, data compiled from stock exchange showed.

This sharp surge in retail participation in derivative markets comes during a period when the markets witnessed wild swings with the benchmark Sensex swinging 16 per cent in a span of three months. Such volatile markets are considered money making opportunities by seasoned derivatives traders. This time, retail traders have also jumped the bandwagon.

Complex strategies such as strangle, straddle and butterfly spreads are becoming popular among retail traders with brokers selling these products as market beating strategies, say experts.

“The last few years have seen more and more investors employing several complex hedged strategies to make 14-15 per cent returns,” said Prashant Prabhakaran, chief executive officer, Yes Securities. “Hedged strategies allow these clients to reduce their rush and make much higher returns as compared to a pure cash market play.”

A large part of the volume spike is coming from new investors transitioning from cash markets, brokers say. The cash market turnover of retail investors managed to witness a modest 15 per cent growth to Rs 38,000 crore during 2018.

The retail volumes in the cash segment have remained stagnant for the last the last five years even as their participation in derivatives has grown exponentially. This transition happened in a much bigger way during 2018 due to poor performance of broader markets and regulatory curbs imposed in several midcap and small cap stocks.

“Trading curbs have certainly reduced the punting opportunities for cash market investors prompting them to explore derivatives, ”said Nitin Kamath, founder, Zerodha. “However, these measures were essential in the larger interest of the market.”

Unlike in several developed markets, there are restrictions that deter Indian investors from short selling a stock without going to the derivatives market. This is limiting the options of individual investors in cash segment, say experts.

In developed markets, investors can short stocks through methods such as stock lending and borrowing (SLB). However, in India the SLB platform has failed to take off, despite several efforts put by the market regulator Sebi.

“If the investors have viable instruments to go short on stocks through cash market, a large part of volume will evaporate from derivatives,” Kamath added.

Brokerages are providing high leverage to derivatives investors allowing them to take massive positions in the market by paying paltry of money. Within derivatives, options are the most preferred instruments for the retail investors, contributing 87 per cent of the retail volume in the segment.

“Lesser tax outgo is another key incentive for investors to shift to derivatives market from cash markets,” said Kamalesh Rao, chief executive officer of Kotak Securities in a recent media interaction.

The securities transaction tax (STT) applicable on cash market transactions is ten times higher than what is paid in derivatives prompting several individual investors to use complex strategies in derivatives market to create a position similar to equity market exposure.

The market regulator Sebi has been concerned about this increasing popularity of derivatives among retail investors. Sebi is currently working on several measures to discourage retail investors from using derivatives including plans to introduce affordability index. Sebi has already written to the finance ministry to reduce the tax parity between the cash and derivatives markets.