How will the Sebi whiplash on F&O transform the stock trading landscape?

According to a study conducted by Sebi, 7 out of 10 individual intraday traders in the equity cash segment have incurred losses in FY2022-23. Image: Shutterstock

Of the many hazards that Covid brought is the rise of trading volume in the derivative markets, or Future and Options (F&O) trading by retail individual investors.
 
The increase in trading volume in F&O and higher retail investor participation in that segment improved businesses for brokerage firms, exchanges and government. So, why did the Securities and Exchange Board of India (Sebi), the markets regulator, intervene to clamp down F&O? Due to major losses incurred by gullible retail investors, making F&O trading a gambling pit.
 

According to a study conducted by Sebi, 7 out of 10 individual intraday traders in the equity cash segment have incurred losses in FY2022-23.  The surge in these trades was unmatchable, rising over 300 percent in the number of individuals participating in intraday trading in the equity cash segment in FY 2022-23 compared to FY 2018-19.
 
There are shocking realities about the massive losses retail investors incur while they gamble in the F&O segment. In FY24, 92.50 lakh unique individuals and proprietorship firms trading in the index derivatives segment of the NSE cumulatively incurred a trading loss of Rs 51,689 crore, according to Sebi. This loss doesn’t even include transaction costs.
 
That has made Sebi worried and its chairperson Madhabi Puri Buch feels that “F&O volume surge has now become a macro issue and not just a micro issue of investor safety”. After multiple warnings highlighting the risk of F&O trading, the regulator has now sprung into action, proposing a series of measures to cut speculative trading, curb volume and thereby reduce risks.
 
The measures proposed by Sebi are seven-pronged. Those are rationalisation of strike price for options, removal of calendar spread benefit on expiry day, upfront collection of options premium, intraday monitoring of position limits, setting a minimum contract size, rationalisation of weekly index products and increase in margin near contract expiry.
 
According to Feroze Azeez, deputy CEO, Anand Rathi Wealth, these measures are expected to lower monthly option prices, especially for OTM (out-of-the-money) options. “This will lead to reduced implied volatility and a more balanced option pricing skew, making the market more accessible and less risky for investors. By concentrating trading volumes on fewer strike prices, liquidity at these levels is likely to be maintained or even improved, which will lower the impact cost for large traders. Overall, these changes are anticipated to promote a healthier trading environment and support sustainable growth in the derivatives market,” he adds.
 
Sebi feels derivatives markets assist in better price discovery, help improve market liquidity and allow investors to manage their risks better. However, bursts of speculative hyperactivity in derivative markets, particularly by individual players, can detract from sustained capital formation by endangering both investor protection and market stability.
 
Meanwhile, the Sebi has also directed that market infrastructure institution (MII) charges collected from end-clients by brokers must match the amounts received by MIIs. This ‘True to Label’ charge structure aims to ensure fairness and transparency and will be effective from October 1, 2024.
 
“This directive will eliminate volume-based discounts. The impact will be more pronounced in the options segment, where potential fee disparity is greater compared to the cash segment. As a result, discount brokers, particularly those with significant trading volumes in the options segment, are expected to see an impact of 15-25 percent on profit before tax (PBT),” says ICRA.
 
That’s not all. In the Union Budget 2024, the government has also increased higher securities transaction tax (STT) on F&O trade to 0.02 percent and 0.1 percent, from 0.0125 percent and 0.0625 percent, respectively. This sizeable increase in the transaction tax incidence, applicable from October 1, will raise the transaction cost for derivatives trading.
 
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How will regulatory changes curb volumes?

“The combined effect of the increase in STT and revised MII charge structure will increase the friction for speculative F&O trading volumes. To maintain profitability, the increase in brokerage charges by 10-20 percent, led by discount brokers, cannot be ruled out,” says ICRA.
 
This adjustment could counterbalance the loss of exchange discounts, but it requires balancing higher fees with competitive dynamics. This may also lead to changes in the business models, such as reassessing brokerage-free offerings, the rating agency explains.
 
According to Sebi, out of the 92.50 lakh unique individuals and proprietorship firms, which incurred loss in index derivatives segment of NSE in FY24, only 14.22 lakh investors made net profit. That adds up to approximately 85 out of 100 made a net trading loss.
 
To put these numbers in perspective, the absolute value of the net trading loss borne by individuals during FY24 in index derivatives is over 32 percent of the net inflows into the growth and equity-oriented schemes of all mutual funds during FY24.
 
However, the playbook isn’t similar when it comes to larger non-individual players. Sebi says that high-frequency algo-based proprietary traders and foreign portfolio investors (FPIs), are, in general, making offsetting profits.
 
Major losses borne by retail investors are expected to see some respite after all the regulatory changes are in place. According to brokerage firm Motilal Oswal Financial Services, if the measures are replicated in the final regulations, volumes are likely to be hit both for retail participation (upfront premium collection and increase in lot size) and for HNIs/high frequency traders (removal of calendar spread benefit and additional margin for expiry).
 
“For brokers, price hikes can offset the impact,” it adds.