Frenzied options trading offers minimal benefits: Sebi’s Ananth Narayan

The Securities and Exchange Board of India (Sebi) is aware of the crucial role of derivative markets in capital formation. However, the chaotic surge in index options trading on expiry dates offers minimal benefits, according to whole-time member Ananth Narayan G.

Referring to Sebi’s consultation paper, which highlighted the explosion in index options trading and retail speculation in derivatives, Narayan, addressing an event on Friday, noted that the proliferation of weekly expiries for index option contracts has resulted in 90% of trading volume occurring on the expiry day, with significant concentration in the last hour of trading.

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While derivatives market and risk takers were crucial in capital markets ecosystem aiding capital formation, this frenzied hyperactivity in index options on expiry day has little discernible benefit, Narayan said. 

As a result, the regulator cannot provide any constructive support for market-wide price discovery, hedging, or capital formation amid this frenzy.

“If there were an unforeseen black swan global market-moving event minutes before expiry, amidst this frenzied activity and risk-taking, the resultant impact on the overall market ecosystem could be substantial. As a regulator, we are conscious that we must not throw the baby out with the bathwater. When it comes to the frenzied trading in options nearing expiry, however, it is very difficult to see any baby in this bathwater,” Narayan said.

Proposals to curb expiry day frenzy

To curb the frenzy and reduce systemic risks, Sebi has proposed seven measures in its consultation paper. These include restricting the number of weekly option expiries, increasing margins around expiry day, removing the benefit of calendar spreads on expiry day, monitoring intraday positions, and rationalizing options strikes.

Narayan also pointed out several areas requiring attention from the industry, market participants, policymakers, and regulators. He highlighted the current mismatch between the demand and supply of securities.

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“The ₹3.1 trillion of net demand for paper brought in by mutual funds, domestic institutional investors, and individuals into the secondary market every year over the past three years far exceeds the roughly ₹2 trillion of annual primary market issuance spanning initial public offerings, follow-on public offers, preferential allotments, qualified institutional placements (QIPs), rights issues, and offers for sale,” he said.

Asset price inflation

Narayan warned that this prolonged mismatch could lead to asset price inflation rather than capital formation. 

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“The price of over 30% of midcap and small stocks has more than tripled over the last three years. While there can be numerous arguments to justify prices, we need issuers—including many members of Ficci—to step up to the opportunity, raise risk capital from our willing investors, deploy it, and create new businesses and household savings, thus ensuring that capital formation sustains as a virtuous cycle,” he added.

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While the market regulator Securities Exchange and Board of India is conscious of the role of derivative markets in capital formation, the frenzied hyperactivity in index options on expiry date has little discernible benefits, said Whole Time Member Ananth Narayan G at a conference today. 

Referring to Sebi’s consultation paper which referred to the explosion in index options trading and retail speculation in derivatives (futures and options), he said that proliferation of weekly expiries for index option contracts led to 90% trading volume on the expiry day with significant concentration in the last hour of trading. 

While derivative markets and risk taker were crucial in capital markets ecosystem to aid capital formation, this frenzied hyperactivity in index options on expiry day had little discernible benefits, he said. For these reasons, the regulator was not able to give any ‘constructive support’ for market wide price discovery, hedging or capital formation for this hyperactivity on expiry day in index options. 

“If there were an unforeseen black swan global market moving event minutes before expiry, amidst this frenzied activity and risk taking, the resultant impact on the overall market ecosystem can be substantial. As a regulator, we are conscious that we must not throw the baby out with the bathwater. When it comes to the frenzied trading in options nearing expiry, however, it is very difficult to see any baby in this bathwater” the WTM said. 

To curb this expiry day frenzy in options trading, and to reduce systemic risks, the regulator came up with seven proposals in its consultation paper, the WTM pointed out. The five proposals of restricting the number of weekly option expiries, increasing margins around expiry day, removing the benefit of calendar spreads on expiry day, requiring the monitoring of intraday positions, and rationalization of options strikes were to tackle the hyperactivity, Sebi clarified.

The WTM also pointed out some areas that warrant attention from the industry, market participants, policy makers along with regulators. The WTM highlighted the current mismatch between demand and supply of securities. 

“The ₹3.1 trillion of net demand for paper brought in by Mutual Funds, Domestic Institutional Investors and individuals into the secondary market every year the past 3 years, far exceeds the roughly ₹2 trillion of annual primary market issuance spanning Initial Public Offerings, Follow-on Public Offer, Preferential Allotment, Qualified Institutional Placement (QIPs) Rights Issue, and even Offer for Sale”, he said. 

He added that prolonged mismatch could lead to more asset price inflation instead of capital formation. “The price of over 30% of midcap and small stocks have more than tripled over the last 3 years. While there can be any number of arguments to justify prices, we need issuers – including many members of FICCI - to step up to the opportunity, raise risk capital from our willing investors, deploy it and create new businesses and household savings, and hence ensure that capital formation sustains as a virtuous cycle” he added.