Union Finance Minister Nirmala Sitharaman.
| Photo Credit: PTI

Finance Minister Nirmala Sitharaman on July 23 proposed to increase the rate of securities transaction tax (STT) on futures and options (F&O) trade to discourage retail investors’ participation in the risky instrument.

“It is proposed to increase the rates of STT on the sale of an option in securities from 0.0625% to 0.1% of the option premium, and on sale of a futures in securities from 0.0125% to 0.02% of the price at which such futures are traded,” she said in the Union Budget speech.

This came after the Economic Survey flagged concerns over rising retail investors’ interest in derivative trading. The survey stated that speculative trade has no place in a developing country.

It also pointed out that the sharp increase in retail investor participation in F&O trading is likely driven by humans’ gambling instincts.

“Derivatives trading holds the potential for outsized gains. Thus, it caters to humans’ gambling instincts and can augment income if profitable. These considerations are likely driving active retail participation in derivatives trading,” according to the Economic Survey 2023-24.

Recently, Sebi chief Madhabi Puri Buch also cautioned investors against heavy bets on F&O. Before that, Ms. Sitharaman and Chief Economic Adviser V, Anantha Nageswaran flagged the growing risk of F&O trading for retail investors.

F&O trading continues to grow in popularity, and market experts believe that this is driven by the potential for profit and the rising trading volumes. Experts said investors who lack understanding or risk appetite should avoid derivatives trading.

The segment’s popularity is evident from its massive growth, with the monthly turnover in the F&O segment reaching ₹8,740 lakh crore in March 2024, compared to ₹217 lakh crore in March 2019.

At the same time, the average daily turnover in the equity cash segment was ₹1 lakh crore, while the F&O segment saw an average daily turnover of about ₹330 lakh crore.

Futures and Options trading involves contracts that derive their value from an underlying asset, such as stocks or commodities. Futures contracts obligate the buyer and seller to transact at a predetermined future date and price, while options give the holder the right, but not the obligation, to buy or sell the asset at a set price within a specific period.

These financial instruments are used for hedging risks, speculating on price movements, and arbitraging price differences. However, they come with significant risks, including leverage risk and market volatility, which can lead to substantial losses.

Futures and Options trading is largely being utilised as a speculative tool for quick profits in the stock market. However, the reality is that most retail investors are losing money.

A study by the Securities and Exchange Board of India (Sebi) revealed that 89 per cent of individual traders in the equity F&O segment suffered losses, with average losses of Rs 1.1 lakh in FY22.

Additionally, there was an exponential increase in the F&O segment participation during the pandemic, with the total number of unique individual traders increasing by over 500% from 7.1 lakh in FY19 to 45.24 lakh in FY21, the study noted.

Earlier, Buch stated that the capital markets regulator is “compelled” to warn against speculative bets in the F&O segment because it has become a “macro issue”, affecting the broader economy now.

Household financial savings are going into the speculative bets, belying the expectations of being used for capital formation, and the youth is losing tonnes of money in such trades, she stated.

Last month, the Sebi board approved stricter norms for the entry of individual stocks in the derivatives segment. The proposal is aimed at weeding out stocks with consistently low turnover from the F&O segment of the bourses.

New Delhi:

The rapid rise in Futures and Options (F&O) trade volumes in recent years could pose several challenges as retail investors not following proper risk management could be impacted by sudden movements in markets, said a Reserve Bank report.

The equity derivatives segment has been witnessing growing participation from retail investors in recent years. It has gone up by 42.8 per cent from 65 lakh during 2022-23 to 95.7 lakh during 2023-24.

While trading volumes in derivatives segment has seen exponential growth over the years in notional terms, the trading volumes when measured by the premium turnover has witnessed a linear growth pattern, said the RBI’s bi-annual Financial Stability Report (FSR).

The ratio of premium turnover to cash market has remained steady over the last three years.

FSR said equity derivatives market can improve price discovery and enhance market liquidity in underlying cash markets. It, however, is also associated with higher risks.

“Since derivatives are more complex than the underlying, investor protection is a key regulatory imperative,” the report said.

A SEBI research published in January 2023 showed that 89 per cent of individual participants in F&O lost money in the segment during fiscal year 2018-19 and fiscal year 2021-22.

“…the rapid rise in F&O volumes in recent years could pose several challenges: retail investors could be impacted by sudden movements in markets without proper risk management and this could have knock-on effects on cash market; rise in popularity of shorter-duration options in indices with few stocks and high volatility could amplify leverage…,” the report said.

The Securities and Exchange Board of India (SEBI) has instituted an expert working group, under the Secondary Markets Advisory Committee, to review F&O markets from the perspective of investor protection as well as overall systemic risk management.

SEBI is also in the process of reviewing the corpus of the Settlement Guarantee Fund (SGF), stress testing methodologies and scenarios for computation of core SGF to build a more resilient settlement system to meet contingencies arising due to failure to honour obligations by any member of a stock exchange.

(Except for the headline, this story has not been edited by NDTV staff and is published from a syndicated feed.)