A SEBI report earlier this month showed that 91 per cent of retail traders incur losses when trading in the equity derivatives segment (EDS), and that this figure has remained largely unchanged over the past four financial years.
However, the net losses incurred by these traders have more than doubled during the same period, rising from ₹41,000 crore to ₹1.06 lakh crore. Meanwhile, the average loss per retail trader has increased more gradually, from ₹96,000 to ₹1.1 lakh.
Since derivatives are a zero-sum game, these losses indicate that some traders have profited at the retail traders’ expense.
The key questions are: who are these traders, and have they earned these profits because the current market structure and regulations in the EDS segment favour them disproportionately?
Retail traders mostly lose
Academic research across countries and over time shows that retail traders typically incur losses, often losing to better-informed institutional investors who also have greater resources.
Therefore, the issue is not about SEBI preventing retail participants from incurring losses, but rather about limiting the scale of these losses.
The major issue with retail participation in India is the soaring popularity of index options.
The SEBI report referenced earlier shows that the average daily value traded by individuals in the EDS has a five-year CAGR of 19 per cent but index options grew by an outsized 82 per cent a year and stock options by 48 per cent a year.
This increase is not accidental; index options carry distinct advantages over index futures and stock derivatives that attract retail traders.
Firstly, index derivatives settle in cash, unlike stock derivatives, which have required physical settlement since 2019.
Physical settlement would require paying the strike price of the options, incurring additional settlement securities transactions taxes (STT), etc., which tend to make physical settlement more expensive when compared to cash settlement.
As a result, traders, including retail, may have migrated to trading index derivatives rather than stock derivatives.
Data from the World Federation of Exchanges supports this: the ratio of notional traded value of index derivatives to that of stock derivatives saw a steep increase from around 7 in 2018 (the year prior to physical settlement of stock derivatives) to 11 in 2019 and all the way to 56 in 2024, with a peak of 69 in 2023.
While volumes have grown across all segments over the seven years, at least some of the growth in index derivatives volumes could be explained by traders’ migration from stock derivatives to index derivatives.
The question then is why the volumes migrated more towards index options than index futures, which leads us to the second advantage of index options: index options have a cost advantage over index futures.
Let us consider the case of Bank Nifty derivatives, which have a lot size of 35 currently and a total margin of 16 per cent.
The Bank Nifty near-term futures price is 57,200. Taking a long position in this futures contract would require an out-of-pocket cost of ₹3.2 lakh as margin.
On the other hand, buying an at-the-money Bank Nifty option with a premium of around ₹350 would require only ₹12,250.
This is a huge difference.
For a trader who has a fixed amount of capital, they could potentially trade more lots of options than futures.
For example, if they have ₹3.2 lakh, they could take a position in one futures lot or 26 options lots.
This is one possible reason for index options volume being greater than index futures volumes.
Data from the World Federation of Exchanges supports this—the ratio of index options notional value traded to that of index futures rose from 32 in 2018 to a whopping 964 in 2024.
This cost issue is further exacerbated by the difference in the way STT is calculated for futures and options.
In both cases, the seller has to pay STT, but for futures, it is calculated as a percentage of the futures price, whereas for options, it is calculated as a percentage of the option premium.
Let me continue with the previous example of the Bank Nifty derivatives to illustrate the impact of this difference.
For reference, the STT on futures is 0.02 per cent and that on options is 0.1 per cent. The seller of the futures would have to pay ₹400 in STT for one lot, whereas the seller of the options would have to pay only ₹12.25 in STT for the same one lot.
This further makes it cheaper to trade options rather than futures.
It is very likely that retail traders understand these advantages and hence prefer to trade index options rather than other derivatives.
What can SEBI do to make index options less attractive?
One step is to revisit the physical settlement requirement on stock derivatives.
While shifting stock derivatives to physical settlement helped reduce stock price volatility—one of SEBI’s objectives—it appears to have pushed volumes toward index derivatives instead.
Conducting detailed studies that track trading patterns at the individual account level would help understand whether traders shifted from stock derivatives to index options.
If this is confirmed, SEBI might consider reverting stock derivatives to cash settlement or finding other ways to reduce the spillover effect.
On the cost side, policy changes could also help. Allowing different lot sizes for futures and options, rather than enforcing identical lot sizes, would better align margin requirements and reduce excessive leverage in options.
Another proposal is to adjust the STT calculation for options to be based on the strike price plus premium, not just the premium, which would narrow the cost gap between options and futures.
It’s important to acknowledge that retail traders will likely continue to incur losses due to asymmetries in information and market experience.
The goal should be to reduce the scale of these losses and promote fairer market participation.
However, in the hopes of creating a more level playing field for retail participants, SEBI should not make trading unattractive for institutional traders because they are still critical to having efficient and liquid markets.
[The author of this article is Associate Professor of Finance (Practice) at Indian School of Business (ISB). Views are personal.]
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Disclaimer: This story is for educational purposes only. The views and recommendations expressed are those of the expert, not Mint. We advise investors to consult with certified experts before making any investment decisions, as market conditions can change rapidly and circumstances may vary.
