A recent study by SEBI highlights significant losses faced by both new and regular traders in the derivatives market during FY24. Individual traders in the F&O segment suffered cumulative losses of Rs 1.8 lakh crore over the last 3 fiscal years with a loss of ₹750 billion in just FY24 alone. The SEBI report analysed the financial impact of trading activities, revealing that even experienced traders were not spared from substantial net losses for trading in F&Os (futures & options).

The report draws attention to the significant increase in index option trading volumes on the National Stock Exchange (NSE), which holds over 90% market share in this segment. The trading volume surged almost 13 times, reaching ₹138 trillion in FY24, up from ₹10.8 trillion in FY20. This exponential growth has prompted SEBI to monitor the market closely, with SEBI chairperson Madhabi Puri Buch highlighting concerns that household savings are being diverted towards speculative trading instead of productive investments. Let’s look at this in depth and what it means for all of us.

Rising Retail Participation in Futures & Options Trading

SEBI has found that there is an increased retail investor demand and participation in speculative trading activities such as trading in F&Os. Retail investors have been channeling their savings into India's rapidly growing options market. Data from SEBI shows that the monthly notional value of derivatives traded reached Rs 10,923 lakh crore ($130.13 trillion) in August, making it the highest globally. A significant portion of this trading is in options contracts tied to stock indices like the BSE Sensex and NSE Nifty 50.

Profitability of Larger Entities

While individual traders struggled, proprietary traders and foreign portfolio investors (FPIs) achieved significant profits. In FY24, proprietary traders booked gross trading profits of Rs 33,000 crore, and FPIs earned Rs 28,000 crore before accounting for transaction costs. A vast majority of these profits—97% for FPIs and 96% for proprietary traders—were attributed to algorithmic trading, highlighting a stark contrast in performance between institutional and individual traders.

The share of individual investors in index options rose sharply to 41% in the financial year ending March 2024, up from just 2% 6 years ago. This surge in retail participation has prompted the regulator to take measures to mitigate risks associated with speculative trading.

Insight #1: High Losses Among New and Regular Derivative Traders in FY24

The analysis shows that nearly 93% of over 1 crore investors - that is about 9/ 10 - incurred an average loss of Rs 2 lakh each during FY22 to FY24. Only 7.2% of individual traders in the F&O market turned a profit over the past 3 years. Of these, just 1% managed to earn more than ₹1 lakh after accounting for transaction costs. Despite facing consistent losses, more than 75% of loss-making traders continued to trade in the F&O segment, even after incurring losses in the previous two consecutive years.

The report also reveals a stark contrast between losses and profits among traders. On average, loss-making traders faced a net loss of Rs 1.20 lakh per person in FY24, while profit-making traders earned a lower average profit of Rs 1.03 lakh per person. This discrepancy suggests that the losses were deeper and more widespread compared to the gains achieved by successful traders.

New Traders Dominate the Market but Face Heavy Losses

SEBI classified 42 lakh traders as 'New Traders' in FY24, representing individuals who entered the Futures & Options (F&O) segment for the first time in the past three years. This group accounted for nearly half of all traders for the year. The study found that 92.1% of these new entrants incurred net losses, averaging around Rs 46,000 per trader.

The study also focused on 'Regular Traders,' defined as those who traded consistently over three consecutive years from FY22 to FY24. These traders constituted 25% of the total F&O participants in FY24. Despite their experience, over 88% of these regular traders suffered net losses, with an average loss of Rs 1.50 lakh per person. This indicates that consistent trading experience did not necessarily translate into profitability.

Top Loss-Makers and Profit Earners

The report highlights that the top 3.5% of loss-makers, approximately 4 lakh traders, suffered severe financial setbacks with an average loss of Rs 28 lakh each over the three years, including transaction costs. On the other hand, only 1% of individual traders managed to earn profits exceeding Rs 1 lakh, after adjusting for transaction costs, underscoring the challenges faced by retail investors in the F&O market.

This study follows an earlier SEBI report published in January 2023, which indicated that 89% of individual equity F&O traders lost money in FY22.

High Transaction Costs Add to Losses

Transaction costs also played a significant role in exacerbating the financial burden on losing traders. The data showed that loss-making traders incurred transaction costs amounting to approximately 27% of their gross losses. In contrast, profitable traders faced transaction costs of about 22% of their gross profits. This additional cost burden further intensified the financial strain on those already incurring losses.

On average, each trader spent around Rs 26,000 on F&O transaction costs in FY24. Over the three-year period from FY22 to FY24, individuals collectively spent approximately Rs 50,000 crore on transaction costs. Of these costs, 51% were attributed to brokerage fees, and 20% to exchange fees.

Despite a rally in the markets during the last fiscal year, traders did not benefit as expected. The findings suggest that speculative trading and high-frequency transactions in the derivatives market led to disproportionate losses, even as market conditions appeared favorable.

Insight #2: Geographical Participation & Trading Patterns in Tier 1 Cities & Beyond

In FY24, more than 50% of all F&O traders were concentrated in four states: Maharashtra, Gujarat, Uttar Pradesh, and Rajasthan. Maharashtra led with the largest share at 21.7%, highlighting its dominance in the segment. These states have consistently shown strong engagement in the derivatives market, contributing significantly to overall trading volumes.

In Tier I cities, derivative traders contributed more to overall turnover but incurred relatively lower losses. Conversely, in B30 cities, traders contributed less to turnover but experienced disproportionately higher losses. This suggests that while traders in major cities engage in higher-volume trading, those in smaller towns and cities are more vulnerable to financial losses.

States That Saw Most Growth In F&O Traders

The data shows a notable increase in the number of traders from Assam, followed by Uttar Pradesh and Bihar, indicating a broadening of the F&O trading base beyond traditional financial centers.

High Losses in Southern States

The report also highlights that the highest average per person losses were concentrated in four southern states:

• Telangana: ₹1.97 lakh per person

• Andhra Pradesh: ₹1.45 lakh per person

• Tamil Nadu: ₹1.37 lakh per person

• Karnataka: ₹1.35 lakh per person

Higher F&O Trading Activity in B30 Cities

F&O traders from B30 cities accounted for 51.3% of total turnover in the individual category but were responsible for 68.1% of total losses. This disparity highlights the increasing activity of investors from smaller towns in the F&O market, contrasting with their lower engagement in mutual funds compared to T30 (Top 30) cities.

The ratio of F&O traders to mutual fund investors is significantly higher in B30 cities compared to T30 cities. For every 100 mutual fund investors in B30 cities, there were 28.6 F&O traders in FY24, compared to 17.8 F&O traders per 100 mutual fund investors in T30 cities. This data suggests that smaller towns and cities are becoming more active in derivative trading, potentially due to the accessibility and perceived profitability of F&O trading.

Insight #3: Young Traders Doing More F&O

The study also revealed that younger traders are increasingly participating in the F&O market. In FY24, traders under the age of 30 accounted for 43% of the total, up from 31% in FY23. However, this demographic suffered a higher loss rate, with 93% of young traders incurring losses, compared to the overall average loss rate of 91.1%.

Insight #4: Decline in Women Traders and Lower Losses Compared to Men in F&O Segment

The proportion of female F&O traders dropped from 14.9% in FY22 to 13.7% in FY24. This indicates a decreasing trend in women's participation in the equity derivatives market over the past 2 years.

The analysis also revealed that female traders tend to incur lower average net losses compared to male traders. In FY24, the average loss per female trader was ₹75,973, whereas male traders faced an average loss of ₹88,804 per person. In FY24, 86.3% of female traders made losses in the F&O segment, compared to 91.9% of male traders. This indicates that, although women are less active in the derivatives market, those who do participate are less likely to incur losses than men.

Insight #5: Lower Income Traders Most Likely To Suffer Losses

SEBI's data also highlighted the financial vulnerability of a large segment of individual traders. Over 75% of these traders, or approximately 6.54 million individuals, reported an annual income of less than ₹5 lakh in FY24. They found that 92.2% of them lost money in F&O trading. And, despite consecutive years of losses, more than 75% of these loss-making traders continued trading in F&O.

The analysis found that as income levels increased, the number of loss-making F&O traders also decreased. This suggests that many retail participants in the derivatives market are engaging in high-risk trading despite having limited financial resources. It also highlights the lack of financial awareness, accessibility to financial data and experts, & other more complex tools that are typically available to higher income traders. SEBI's findings underscore the need for heightened awareness and potential regulatory intervention to protect individual investors, particularly those with limited financial means.

Insight #6: Zero Sum Game - Quant & Algorithm Investing Remains Profitable for FPIs & Prop Traders

Majority of profits earned by FPIs (97% of total profits) and proprietary traders (96% of total profits) in the F&O segment were generated through algorithmic trading. The analysis defined algorithmic entities as those traders that have executed at least 1 trade using algorithmic orders within 1 year. However, in contrast, individuals and other categories of traders incurred significant losses when they engaged in algorithmic trading - with a collective loss of ₹27,700 crore for individual traders using algorithms in FY24.

• Out of 376 FPIs trading in the F&O segment, 306 engaged in algorithmic trading.

• Among 626 proprietary traders, 347 used algorithms.

• Only 13% of the 95.7 lakh individual traders employed algorithmic trading.

In FY24, 99.3% of traders in the F&O segment were engaged in options trading, while only 5.9% participated in futures trading. This shift is attributed to the lower cost of trade and reduced capital requirements associated with options.

There is a relatively low adoption rate of algorithmic trading among retail investors, who often lack access to the sophisticated tools and technologies used by institutional entities. The report also highlights that some of the retail trades classified as algorithmic were actually forced liquidations by brokers to square-off intraday positions. This suggests that the use of algorithms among retail traders may not always be a deliberate strategy but rather a response to market conditions or broker interventions.

Proposed Changes to Futures & Options Derivative Trading Rules

SEBI plans to implement stricter regulations on derivative trading to raise entry barriers and increase the cost of trading for retail investors. The move aims to reduce speculative trading in risky contracts, according to 4 sources with direct knowledge of the matter. SEBI intends to limit the number of options contract expiries to one per exchange per week and significantly increase the minimum trading amount, the sources stated. These measures resemble proposals issued in July, which faced opposition from traders and brokers. Despite the pushback, SEBI is determined to go forward with the rules.

Key Aspects of the Final Rules for Futures & Options Trading

1. Reduction in Expiry Options: Exchanges will be required to reduce the number of contract expiries to one per week from the current multiple expiries, which facilitate speculative trading.

2. Increased Minimum Trading Amount: The minimum trading amount will be raised to Rs 15-20 lakh ($18,000-$24,000) from the current Rs 5 lakh, as proposed in the July consultation paper.

3. Revisions in Margin Requirements: While higher margins for contracts expiring on the same day were initially suggested, the feedback indicated this would be difficult to implement. SEBI is likely to adjust the proposed margin increases.

4. Intraday Position Monitoring: Exchanges and depositories expressed concerns over the feasibility of intraday monitoring due to technical constraints. SEBI may not enforce this requirement at present.

Impact of Proposed Changes on Different Stakeholders

Impact of F&O Changes on Individual Traders

1. The proposed increase in the minimum contract size and collection of premium upfront will substantially raise the capital requirements for individual traders.

2. The removal of margin benefits on calendar spreads and the reduction in the number of weekly options contracts will further restrict trading activities.

3. These measures are likely to push many small-scale traders out of the market. According to NSE data from May 2024, 80% of traders in the options market had a monthly turnover of less than Rs 10 lakh.

4. For these small traders, the increased capital requirements could act as a deterrent, significantly reducing their participation.

Impact of F&O Changes on NSE vs. BSE

NSE is expected to be more affected by the proposed rule allowing only one weekly option per exchange. Currently, NSE has 4 weekly expiries—Nifty, Bank Nifty, Fin Nifty, and Nifty Midcap—compared to BSE’s 2 weekly options, Sensex and Bankex.

These changes will impact the earnings for both NSE & BSE - with NSE’s FY26 earnings falling by 25-30%, whereas BSE might see a 15-18% impact. However, some analysts believe BSE could benefit if traders, who previously focused on NSE options, shift their activities to BSE. Jefferies projects that despite a potential 7-9% impact on BSE’s EPS due to the removal of the Bankex weekly contract, the exchange could experience an EPS upgrade if trading spillover from discontinued products occurs.

Impact of F&O Changes on Brokers

Discount brokerages such as Zerodha, Angel One, Paytm Money & others are expected to feel the brunt of these changes more acutely than traditional brokerages as they rely heavily on high trading volumes from cost-sensitive retail investors. With the anticipated fall in trading volumes, these firms face significant pressure on their revenue. Increasing brokerage fees to compensate could drive away their primary customer base.

Traditional brokers, such as Motilal Oswal, IIFL Securities, and ICICI Securities, are also expected to be impacted, but to a lesser extent. These brokers have more flexibility to adjust their pricing structures and may pass on the costs to clients through higher fees.

Impact of F&O Changes on Large Traders & Institutions

HNIs, FIIs, and High-Frequency Trading (HFT) firms could benefit from the new regulations. These measures might lead to lower monthly option prices, especially for Out-of-the-Money options. This would result in reduced implied volatility and a more balanced option pricing skew, making the market less risky and more accessible to experienced traders. However, this could also mean reduced profits for large players who have traditionally earned by capitalizing on the inexperience of retail traders.

Final Thoughts

SEBI's report reveals that individual traders in the F&O market suffered cumulative losses of ₹1.8 lakh crore over the past three years, contrasting with significant profits made by proprietary traders and FPIs using algorithmic trading. Despite growing retail participation, especially from younger traders and those in B30 cities, most faced substantial losses.

SEBI's proposed regulations, such as increasing minimum trading amounts and reducing contract expiries, aim to curb speculative trading but may also reduce market liquidity and impact earnings for exchanges and brokers. The findings highlight the need for enhanced financial literacy and regulatory measures to protect retail investors from high-risk trading in derivatives.