The Securities and Exchange Board of India (SEBI), India’s capital markets regulator, is clearly concerned about the high level of retail investors’ involvement with equities market derivatives. It may be noted that far too many people have just entered the F&O (Futures & Options) game, and it is highly unlikely that they completely understand the risks that they are incurring for the sake of the gains they are seeking. A recent research found that during the Covid pandemic, the total number of unique individual F&O traders increased by more than 500% from 710,000 in 2018-19. People were stuck at home with additional time and money, which fuelled a surge of excitement for this heightened degree of trading in the F&O segment. Overall, this should have thrilled any regulator who wants to see more people participate in financial markets. However, futures and options trading is a field for specialized players such as institutional traders. Hence retail money in play is more likely to reflect risky bets than calculated bets on price fluctuations or other investing techniques that utilize derivatives to manage or hedge risks.
According to informal data, the desire of making quick cash has contributed to India’s F&O rise in recent years. The risk of F&O transactions can be mitigated by establishing counter positions, but unfavourable price fluctuations may still inflict severe losses. To see how complex all of this may be, consider the winner-loser ratio reported by SEBI’s latest study. Only one out of every ten individual traders profited in the equities F&O category. The average loss suffered by losing traders was more than fifteen times greater than the average gain made by winners. Obviously, the chances are skewed against retail players. Often, they lack the data expertise and market understanding that institutional traders have. What keeps the retail investors interested in high-risk derivatives is the opportunity to place low-ticket, high-bounty betting on fluctuating asset values. Derivative transactions need less upfront cash because the majority of low-cost broker platforms provide leverage for trading in derivatives. This really entices retail players to make quick money with little cash, and as a result, they lose the full capital owing to the negative impacts of trading on margin. Trading on margin given by the broker platform is nothing but using leverage or loan to place trades. This derivatives trading will create a risky cycle in which retail investors will become more aggressive in their attempts to recover their losses and risk losing even more money. As the F&O segment’s low win percentage illustrates, it is easy to fall into the overconfident zone of trading that goes wrong more often than right.
Though there is a 90% possibility that an investor may lose money in the F&O segment, we also know, and statistics indicates, that if you have a long-term outlook of the market (at least 7 to 10 years), and invest with a long-term standpoint, you will seldom go wrong. Individuals ought to invest in equities through various holdings held for extended periods of time, focusing on dividends rather than capital gains. This is not only safe, but it also aligns with the purpose of financial markets in allocating capital to businesses that can better employ them, thereby contributing to economic efficiency as well.
