SEBI is closely monitoring F&O trading due to a recent surge in retail investor participation and the associated risks. The regulator believes that a significant portion of F&O trading is speculative, rather than focused on hedging or risk management. SEBI Chairperson Madhabi Puri Buch highlighted in July 2024 that households are losing up to Rs 60,000 crore annually in the futures and options segment, which could lead to increased market volatility and systemic risks.
Data indicates that a large number of retail investors incur losses in F&O trading, raising concerns about the negative impact on household savings and the overall financial well-being of investors. A SEBI study previously revealed that 90% of F&O trades result in losses. In response, the capital markets regulator issued a consultation paper with proposals aimed at curbing speculative activity.
Key measures include increasing the minimum contract size, reducing the number of weekly options contracts, requiring upfront collection of option premiums, and limiting the number of strike prices on expiry day.
Futures and Options (F&O) trading in India, while potentially lucrative, comes with significant risks. Here are the top risks associated with F&O trading:
1. Leverage Risk
High Leverage: F&O trading allows traders to take large positions with a small amount of capital. While this can amplify profits, it also magnifies losses, potentially leading to losses exceeding the initial investment.
2. Market Volatility
Price Fluctuations: F&O markets can be highly volatile. Sudden price movements can lead to significant losses, especially if the market moves against the trader’s position.
3. Liquidity Risk
Low Liquidity: Some contracts, especially those of less popular stocks or far-out expiries, may have low liquidity. This can make it difficult to enter or exit positions without affecting the price, leading to slippage and potentially larger losses.
4. Time Decay
Options Premium Erosion: For options buyers, the value of an option decreases as the expiration date approaches, due to time decay. This can result in a loss even if the underlying asset moves in the desired direction but not enough to cover the time decay.
5. Margin Calls
Additional Capital Requirement: If the market moves against a trader’s position, the broker may require additional margin to maintain the position. Failure to meet a margin call can result in the broker closing the position at a loss.
6. Complexity and Misunderstanding
Lack of Understanding: F&O trading involves complex strategies and instruments. Traders who do not fully understand these can make poor decisions, leading to significant losses.
7. Counterparty Risk
Default Risk: Although exchanges usually mitigate this risk through clearinghouses, there is still a minimal risk that the counterparty might default on the contract, particularly in the case of over-the-counter (OTC) derivatives.
8. Regulatory Risk
Changes in Regulations: The regulatory environment can change, affecting trading conditions, margin requirements, and the overall F&O market structure. Such changes can impact traders unexpectedly.
9. Emotional and Psychological Risk
Stress and Decision-Making: F&O trading can be stressful, leading to emotional decision-making. Traders may overreact to market movements, leading to impulsive trades and significant losses.
10. Systemic Risk
Market-Wide Impact: Economic downturns or financial crises can impact the entire market, leading to widespread losses in F&O positions regardless of individual stock performance.
Due to these risks, traders must have a solid risk management strategy, adequate capital, and a thorough understanding of F&O markets before engaging in trading.
SEBI-appointed Expert Group
The SEBI-appointed expert group on exchange-traded derivatives has started discussions on seven proposals to address regulatory issues and protect small investors from risks in index and stock option trading.
The rapid rise in F&O trade volumes in recent years could pose several challenges as retail investors who are not following proper risk management could be impacted by sudden market movements, a Reserve Bank report stated.
The equity derivatives segment has been witnessing growing participation from retail investors in recent years, increasing by 42.8% from 65 lakh in 2022-23 to 95.7 lakh in 2023-24.
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