PostMortem of SEBI’s consultation paper on “Measures to strengthen index derivatives framework for…
SEBI’s new business plan seems like the story of Kalidasa who tried to cut the branch of the tree on which he was sitting. The segment making the most money for the regulator is at the risk of facing the axe i.e. futures and options (FnO).
A government entity trying to help retailers save money is indeed pretty good, but what is getting done is the real opposite. They are planning to increase the margin requirements that may force the small-scale traders to borrow funds to participate.
Regarding the loss making scenario, every profession or category has a similar success ratio.
- 2529 candidates clear UPSC Mains and qualify for interview out of 11.52 lakh applicants ie a win ratio of 0.2%
- The number of people getting an IIM seat is 2.17%
- I do not have the data on the percentage of entry level employees that go on to become a C suite executive, I assume it would be less than 10%.
So when it comes to trading, what is the rationale for expecting more percentage of people should win?
Even if the level of entry is revised upwards from 5 Lakhs to 25 Lakhs, the percentage of losers will still be the same. Please enlighten me if any stock market in the world that has a better win percentage than India. The reason intellectuals and professionals are participating in trading is because they believe their merit will help them win.
If you bring in externalities, the markets will not be clear and people will go back with the impression that pure merit will not work. This system will get corrupted like all the other categories that work on “the people you know”, “the bribe you can give” and the “money in your pocket”.
The 18 page pdf published by SEBI can be found — click here. We will analyze a few points today.
- Heightened speculative trading — Yes, India is the leader in the volumes of derivative trades surpassing major economies like the US, UK, Japan and China.
The reasons are 100% man made.
- Just after Covid, the exchanges, regulators and brokers withdrew the intraday leverage for stock trading. Earlier brokers used to provide between 1:10 to 1:100 leverage for intraday stock trading and 1:5 to 1:20 for Buy Today Sell Tomorrow (BTST) overnight trades. Why did the exchange withdraw that scheme? To protect the investors. The after-effect was that traders were forced to look out for better trading opportunities. The only refuge for them to stay afloat was to trade in Futures and Options (Fno), specifically options.
- The reassurance came when the exchanges decided to open up FinNifty, Midcap Nifty Select, Sensex, and Bankex weekly options along with shifting BankNifty out from Thursdays to Wednesdays. This unique positioning enabled we had an expiry day every day of the week.
Even though people did not prefer to trade options, they were compelled to do it by the above two steps. If they bring back intraday leverage on stocks, much of this issue will automatically fade out.
- The last half an hour is the most volatile — The interesting thing to note here is that retail traders do not really cause the volatility, it is caused by big sharks who feed on retail traders.
Let me bring in the analogy of fishing so that you understand it better. HFTs (High Frequency Traders) and Institutions (DIIs & FIIs) have better access to data than ordinary retail traders like me. They can run a few queries and find out what all are the vulnerable trading positions.
All they have to do is take the markets there for a quick moment and scare the s*** of the traders and they would cover their positions for a loss. These losses are easy profits for the HFTs and they can unwind the positions that they took to manipulate the markets. The end result — markets are where they were and money has flown from retail trader’s pockets to HFT’s pockets.
I cannot blame the HFTs, because you go fishing where the fish are. The fish doesn’t know what is happening whereas the fisherman is prepared with his big net.
The regulator’s current plan is to educate the fish to be aware of the fisherman. They are even asking the smaller fishes not to participate and let the medium size and large size fishes play this game.
If activities like last 30 minutes volatility, and stop loss hunting were to be curbed, then the steps should be taken to punish the fishermen and not the fishes. Simply make the markets non-manipulatable or ban HFTs who does that.
- Absolute value of losses > inflows into mutual funds. Ideally, there is no value of losses in isolation. You should also add the value of profits into the equation and then assess.
Comparing the loss making volumes to the inflow of Mutual Funds shows the lack of imagination of the researcher. Technically there is no way to prevent the losses, it is part of the game. Someone’s losses are going into another person’s profits and the government is getting profits either way (both from loss making and profit making participants). If the Govt. were so concerned for the loss making traders, they would have given him tax exemption.
- Collect premiums from option buyer. To explain this point, let us consider the 51000 PE which is trading at Rs10 today 31st July 2023 when BankNifty spot is at 51544.
51000 PE is out of the money and will most likely go to zero if BankNifty stays above 51000 today (Another 2.5 hours to go).
To Buy 1 lot ie 15 Qty, the amount I have to spend is 15*10 = Rs150. Whereas to Sell 1 lot ie 15 Qty, the margin required = 15650.
The contract is only valid for Rs150 and that too for 2.5 hours. If the exchange mandates that you need to keep a margin of Rs15650 to buy a product worth 150 — will that really work out?
It is like walking into the fruit store and buying a kilo of apples for Rs300, but you need to keep your motorcycle as collateral. Once you finish eating the apples, you may pay Rs300 and take back your motorcycle. Will you agree to these terms?
- Upward revision of contract sizes. This is an excellent move, but will only make it worse for the loss makers. You are increasing the threshold required to play, only forcing the lower rung of participants to borrow and then trade.
If the intent is to protect the poor person, then the items have to be made cheaper. Somehow we live in a society that believes if we increase the rate of cigarettes then the poor people will not smoke. What actually happens is that poor people continue to smoke by spending more and becoming poorer.
I am an active market participant since 2010 as a trader, sub broker, author, MFD and columnist and an active student of economics. The above explanations are just my thoughts and maybe totally wrong, only time will tell.
If I feel a few other points require detailed explanation, I may revisit this page & edit accordingly.
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