SEBI examines the increase in option trades

An Overview

Concerned about the significant shift in trading activity from the cash market to options, the Securities and Exchange Board of India (SEBI) has advised brokers to raise investor knowledge of the hazards of such products, particularly among new entrants.

The capital markets regulator is believed to have inquired about the causes for the increase in options trading during a recent meeting with top executives of market intermediaries.

Reportedly, SEBI authorities wanted to know whether the increase in option positions was for hedging or directional bets. Both the BSE and the NSE have stated that they have recently intensified their investor awareness initiatives.

Surge in options’ popularity

Options have grown in popularity in recent years as a result of simpler funding, which allows traders to make larger bets at lower costs than stocks. They’re also seen to be safer than futures. The highest risk for the buyer is the premium he pays to purchase the option. In theory, an options seller – the counterparty — is exposed to unlimited losses.

Buying options is now far less expensive than intraday trading, and writing options is equally simple with brokers who accept shares as collateral.

SEBI is worried that retail traders, particularly newcomers, are placing bets without fully comprehending the dangers. Exchanges and brokers are considering creating a system that sends popups to retail investors with open unhedged holdings, underlining the risk inherent in such transactions.

With the first leg of the tougher peak margin rule set to take effect in December 2020, the shift to options has intensified.

Big buck bets

Cash market volumes have decreased by 8%, while option segment turnover has increased by 160 percent, from Rs 27 lakh crore in November 2020 to Rs 63 lakh crore in September 2021.

SEBI’s new methodology for peak margin requirements may have dampened futures activity as well. Brokers must collect upfront margins on leveraged trades under the new peak margin rules. Previously, they were collected by brokers at the end of the trading day.

The maximum margin requirement was raised to 100 percent on September 1, requiring traders to pay the entire margin before completing a transaction. Investors with hedged positions profit from low margins in options, but in cash and futures trading, clients must maintain 100 percent margins for the time being.

Daily option volumes averaged Rs 59.37 lakh crore in August, up from Rs 42.15 lakh crore in May and Rs 34.70 lakh crore in January. Cash market volumes have constantly fallen, from Rs 84,300 crore per day in May to Rs 68,173 crore in August, a 19 percent drop. On both exchanges, average daily volumes in the futures market were Rs 1.06 lakh crore in August, compared to Rs 1.17 lakh crore in May and Rs 1.25 lakh billion in January.

Frequently Asked Questions (FAQs)

What is option trading?

As a newbie, one way to think of options is as a tool to make stock market wagers. This investment type can be utilised to safeguard against stock losses by hedging against stock investments. Depending on your trading technique, options can also be used to earn regular income.

Are options more risky?

Because of their complexity, option contracts are famously volatile but understanding how they function can help mitigate the risk. Risk can range from a modest prepaid amount of the premium to unlimited losses, depending on which “side” of the contract the investor is on.

Is it wiser to buy or sell calls and puts?

Purchasing a call results in an immediate loss with the possibility of future profit, with risk limited to the option’s premium. Selling a put, on the other hand, provides an instant profit / inflow with the potential for future loss and no risk limit. So, it all depends on your risk tolerance.