The real gainers from F&O 'casino'

There was much alarm, surprise, and consternation last week when the Securities and Exchange Board of India (Sebi) released a study showing that 90 per cent of the active traders dabbling in derivatives such as futures and options (F&O) lost money in FY22. Even as more and more people tried their hand in F&O, in the post-Covid period, more lost money; in FY19, 87 per cent of the derivatives traders were losers, and this went up to 90 per cent in FY22. The number of individual traders who traded through Sebi’s study sample (of the top 10 brokers in the equity F&O segment) was 4.52 million in FY22, up from just 710,000 during FY19 — a stunning rise of over 500 per cent. Of these, 88 per cent were active traders.
 

If nine out of 10 individual traders make losses in derivatives, over different time periods and different sample sizes, it shows how useless and harmful derivatives are. Some feel the obvious step for the regulator would be to ban derivatives, but it is a complex issue. Some blame individual traders for getting attracted to the ‘casino’ called derivatives like moths to fire. Most people would tend to blame the mushrooming broking firms providing algo trading, which lures traders with fast mobile apps and “sure-fire” trading strategies. In FY22, nearly 35 per cent of the F&O players were in the 20-30 age group, rising from just 11 per cent in FY19. One predictable outcome is demand for more curbs on individual F&O traders. Sebi’s reaction is also along expected lines: To issue guidelines for additional risk disclosures to investors by brokers and exchanges. Maybe Sebi could benefit from a further study on investor behaviour before and after “risk disclosure” for various products and check whether more disclosures will achieve anything tangible.
 

How should we treat this study on derivatives? Are there any policy implications? Should derivatives be banned for individual traders? These questions cannot be addressed before we understand an equally important fact. Who has a vested interest in the massive trading volumes generated in the derivatives segment? Who gains from the higher activity of the ‘casino’? While the story of 90 per cent of the traders losing money is startling, equally significant is a piece of data that appears at the end of the Sebi study. Whether they make or lose money, traders have to incur transaction costs, including brokerage, exchange fees, turnover fees, and securities transaction tax, etc. These make up a large portion of their total loss. According to Sebi’s analysis, in FY22, over and above the net trading losses incurred, losers in the group of active traders were out of pocket by an additional 28 per cent of net trading losses as transaction costs. Even active traders making trading profits spent 50 per cent of such profits as transaction cost! Transaction costs for traders are revenues for three entities.
 

What the Sebi study will not tell you is how much money is being collected by these three entities on every single trade, irrespective of anyone making gains or losses. The higher the trading volume, the greater is their guaranteed income. These three beneficiaries are Sebi (charges turnover fees), the National Stock Exchange, or the NSE (a variety of fees and charges), and the government (which collects goods and services tax, securities transaction tax, and stamp duty). Then there is brokerage cost although all brokers now charge a flat fee (such as Rs 20) per trade, irrespective of the size of the trade. But Sebi, the NSE, and the government continue to extract their pound of flesh as a percentage of trading volumes. The higher the trading, the greater is their takings. That leads us to this depressing conclusion: Even as the number of traders jumped 500 per cent in three years and trading volumes exploded, even as 90 per cent of the traders lost money, these three entities profited immensely. Of those, two are government entities and one is a near monopoly.
 

The biggest beneficiary is the NSE, where F&O trading has grown a stupendous five-fold in less than four years between FY19 and FY22. The NSE’s Annual Report proudly displays it has 39 per cent of the global derivatives market in terms of the number of contracts, far ahead of the Brasil Bolsa Balcao (17 per cent) and Iran Fara Bourse Securities Exchange (14 per cent). Two markets in the US — the Nasdaq (4 per cent) and the Chicago Board of Options Exchange (4 per cent) — are way behind. No other rich country is anywhere on the list of top 10 derivatives ‘casinos’. The overwhelming source of the NSE’s profit is its 100 per cent dominance in F&O. How profitable is the NSE? Its net profit has gone up from Rs 1,708.84 crore in FY19 to Rs 5,198.29 crore, a jump of three times in three years! The NSE’s operating margin last year was 78.6 per cent and net margin was 59.5 per cent. There is possibly no large business anywhere which makes this kind of margin. As the NSE’s Annual Report claims, in 10 years the volumes in single-stock derivatives increased 5.4 times. In FY22 alone, derivatives trading jumped 20 per cent.
 

While the story of the derivatives ‘casino’ is startling, with its revelation that millions of traders are losing money trading derivatives, don’t expect any change. The NSE has to remain colossally profitable, while just this fiscal year the government will collect Rs 32,000 crore from securities transaction tax — 100 per cent higher than in the previous year! The bulk of this comes from F&O. While derivatives are a harmful product and we will continue to blame traders for gambling and losing, the show must go on. The ‘casino’ has to grow bigger and bigger for the three to extract their rising toll.

The writer is editor of www.moneylife.in

Twitter: @Moneylifers