There was much alarm, surprise and consternation last week when the market regulator, the Securities and Exchange Board of India (SEBI), released a study showing that 90% of active traders dabbling in derivatives such as futures & options (F&O) lost money in FY21-22. Even as more and more people tried their hand in F&O, in the post-COVID period, more lost money; in FY18-19, 87% of derivatives traders were losers, which went up to 90% in FY21-22. The number of individual traders who traded through SEBI’s study sample (of the top 10 brokers in the equity F&O segment) was 4.52mn (million) in FY21-22, up from just 710K (thousand) during FY18-19, a stunning rise of over 500%. Of these, 88% were active traders.
If nine out of ten, 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 that lure traders with fast mobile apps and ‘sure-fire’ trading strategies.
In FY21-22, nearly 35% of the F&O players were in the 20- 30 years age group, rising from just 11% in FY18-19. One predictable outcome is a 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% of 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. These make up a large portion of their total loss.
According to SEBI’s analysis, in FY21-22, over and above the net trading losses incurred, losers in the group of active traders were out of pocket by an additional 28% of net trading losses as transaction costs. Even active traders making trading profits, incurred 50% of such profits as transaction costs! Transaction costs for traders are revenues for three entities.
What SEBI Will Not Tell You
What 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 higher their guaranteed income.
These three beneficiaries are: SEBI (charges turnover fees), the National Stock Exchange (NSE) (a variety of fees and charges) and the government (which collects goods and services tax-GST, securities transaction tax-STT and stamp duty). Then, there is brokerage cost, although all brokers now charge a flat fee (such as Rs20) per trade, irrespective of the size of the trades.
But SEBI, NSE and the government continue to extract their pound of flesh as a percentage of the trading volume. The higher the trading, the higher their take.
That leads us to this depressing conclusion: even as the number of traders jumped 500% in three years and trading volumes exploded, even as 90% of traders lost money, these three entities profited immensely. Of them, two are government entities and one is a near monopoly.
The biggest beneficiary is the monopoly casino-owner NSE, where F&O trading has grown a stupendous five-fold in less than four years between FY18-19 and FY21-22. NSE’s annual report proudly displays that it has 39% of the global derivatives market in terms of the number of contracts, far ahead of the Brasil Bolsa Balcao (17%) and Iran Fara Bourse Securities Exchange (14%).
Two markets in the US, NASDAQ (4%) and Chicago Board of Options Exchange (4%) are way behind.
No other rich country is anywhere in the list of top-10 derivatives casinos.
The overwhelming source of NSE’s profit is its 100% dominance in F&O. How profitable is NSE? Its already obscene net profit has gone up from Rs1,708.84 crore in FY18-19 to Rs5,198.29 crore, a jump of three times in three years! NSE’s operating margin last year was 78.6% and its net margin was 59.5%. There is possibly no large business anywhere which makes this kind of margin. As NSE’s annual report claims, in 10 years, volumes in single stock derivatives, increased 5.4 times. In FY22 alone, derivatives trading jumped 20%.
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 year government will collect Rs32,000 crore from STT in FY22-23, which is 100% higher than 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 will go on. The casino has to grow bigger and bigger for three to extract their rising toll. They have too much of vested interests at stake. That’s why SEBI will only come with more 'disclosure' about the perils of F&O, which will be ineffective.
(This article first appeared in Business Standard newspaper)