India tightens rules on derivatives trading after retail options frenzy

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India’s capital markets regulator has raised barriers to derivatives trading to curb the frenzy among millions of young retail investors who have piled on high-risk options and short-term bets on the booming stock market of the country.

The Securities and Exchange Board of India imposed tough measures on Tuesday, including raising the minimum contract size for index derivatives by about three times to at least Rs 1.5 million ($18,000). It has also reduced the amount of weekly options contracts tradable to one per exchange since November.

The crackdown comes after regulators and India’s finance ministry have repeatedly issued warnings about the risks involved in derivatives markets. Investors can use options to leverage their bets, borrowing multiple times the amount they have on deposit, but they can magnify both their losses and their gains.

The Indian stock market has soared in recent years as the country has become the world’s fastest-growing large economy. As growing numbers of middle-class households increasingly invest their savings in domestic stocks, analysts have compared the feverish interest in derivatives trading to gambling in a country where betting is not legal.

“The cult of equities has grown in India,” said Kranthi Bathini, director of equity strategy at WealthMills Securities in Mumbai.

The problem is “uninformed, uneducated investors are falling prey to this speculative retail frenzy, this is where regulation and the finance ministry come in,” he added.

Many Indians have also been buoyed by a proliferation of cheap discount online brokerages and popular, if largely unregulated, “finfluencers” who offer trading tips on social media.

In a recent study, Sebi said less than one in 10 futures and options traders made a profit. Its latest order noted the trend of “increased retail participation” as well as “increased speculative trading columns in index derivatives on expiry day”.

Research by Mumbai-based Axis Mutual Fund showed that the number of active derivatives traders in India rose to 4 million last year, compared to less than 500,000 before the coronavirus pandemic. Most lived in the country’s smaller towns and were under 40 years old.

The trend attracted global attention after the notional value of options on India’s benchmark Nifty 50 surpassed that of the S&P 500, and quant trading firm Jane Street reportedly made $1 billion on the trades on the options market in the country last year.

Sebi’s move is just the latest attempt to cool India’s retail frenzy. While its last order was issued after local market hours, in July shares of listed Indian brokerages, which have benefited from the derivatives boom, fell after new rules imposed flat fees that are not discounted for volumes increase.

The regulator’s new restrictions “would have some impact,” Bathini said.