NSE’s plan to extend derivatives trading hours will hit small investors hard
With allowing F&O alone at extended trading hours, the concept of underlying assets is sacrificed; it's like building castles in the air without a foundation
It has been reported that the National Stock Exchange (NSE) is finalising plans to extend trading hours for equity derivatives. The exchange has reportedly proposed an evening session, possibly between 6 pm and 9 pm, when market participants can continue trading futures and options (F&O) contracts after the regular session between 9.15 am and 3.30 pm is over. It is possible that in the future it may extend the session even up to 11.30 pm.
The justification for introduction of the extended hours is stated to be to offer an opportunity to react to global events sooner. The NSE has submitted its plan to the Securities Exchange Board of India (SEBI) for approval.
The move is an ill-conceived one considering the following aspects.
Ideally, the purpose of any derivative trade (F&O) should be a hedging operation. It is with the purpose of mitigating/reducing the risk associated with investment in stocks. However, market participants use derivatives for speculation and arbitrage purposes. Allowing some speculation may be necessary for the purpose of having sufficient depth in the derivatives market. But a disproportionate amount of trading in derivatives will be detrimental.
But a recent study by SEBI reveals that there are rampant speculative activities in derivatives, which has resulted in a significant number of investors incurring loss. Let us see the details of the study.
Findings of SEBI study
SEBI had conducted the study with an objective to analyse the trading by individual investors with regard to net profit/ loss incurred by them in the equity F&O segment for the period FY19 and FY22. The periods of study have been suitably selected keeping in view the influx of individual investors in the last three years, so as to comparatively analyse the trends before and after the COVID-19 outbreak.
The study revealed the following significant trends:
Number of participants: The total number of unique individual traders who traded through a sample of top 10 brokers in the equity F&O segment was 45.2 lakh during FY22, up from 7.1 lakh during FY19 (significant increase by over 500 per cent in FY22 as compared to FY19) – of this 88 per cent were active traders.
Loss-makers: Eighty nine per cent of the individual traders (i.e. nine out of 10 individual traders) in the equity F&O segment incurred losses, with an average loss of ₹1.1 lakh during FY22, whereas, 90 per cent of the active traders incurred average losses of ₹1.25 lakh during the same period.
For the group of active traders (excluding outliers), on average, loss-makers registered net trading losses close to ₹50,000 in FY22.
For the group of active traders (excluding outliers), the average loss of a loss-maker was over15 times the average profit by a profit maker during FY22.
Profit-makers: During FY22, 11 per cent of individual traders in the equity F&O segment made an average profit of ₹1.5 lakh. The percentage went down marginally to 10 per cent for active traders, though the average profit made by them went up to ₹1.9 lakh during the same period.
For the group of active traders (excluding outliers), only 6 per cent of individual traders in the equity F&O segment made profit with an average profit of nearly ₹3,400 in FY22.
The top 1 per cent and top 5 per cent of active profit-makers accounted for nearly 51 per cent and 75 per cent of the total net profit earned by all active profit makers, respectively.
The above study is behind SEBI’s directive to stock broking firms to compulsorily put a notice for investors about the risk in derivatives whenever the investors place orders in the derivative market.
What’s the takeaway?
If, with the present trading hours, the number of participants has increased by 500 per cent over the last three years, what will happen when the window is extended by another three hours?
Derivative means that it derives its price or strength from the underlying asset. The security traded in the cash market is the underlying asset. The trading of options and futures must be based on this. Not the other way round. By allowing futures and options alone with extended trading hours, the concept of underlying asset is sacrificed. It is like building castles in the air without a foundation.
At a time when a majority of the participants are incurring loss, the regulator must tighten the speculative activity. Extending trading hours for derivatives will only increase the chances of more and more derivative traders losing money. The regulator must protect individual small investors.
Extending trading hours may only increase income for the brokers and the exchange at the cost of investors.
We have to wait and see how SEBI reacts to the proposal.