Trends in Equity Derivatives Trading: A Look at Prop Traders and Market Regulations
Recent trends in equity derivatives trading reveal a concerning decline in turnover among proprietary traders, particularly in the index options sector. Despite a market rally, proprietary traders reported a significant decrease in their gross premium turnover in August, reflecting ongoing market dynamics and the tightening of regulatory measures. This decline is expected to continue as we venture into September, with signs of moderation observed in individual turnover as well.
According to exchange data, prop traders saw a gross premium turnover in index options drop by 9.5% to ₹11.56 trillion in August compared to July, highlighting a troubling shift in trading behavior during a period generally characterized by bullish market sentiment. In contrast, individual client turnover experienced a smaller decline of 4.66%, totaling ₹8.61 trillion during the same timeframe.
Preliminary data from September indicates that this downward trend has persisted, with total index options premium turnover declining nearly 7% to ₹11.37 trillion, according to the National Stock Exchange (NSE).
On July 31, the Securities and Exchange Board of India (SEBI) released a consultation paper titled “Measures to Strengthen Index Derivatives Framework.” This paper proposed seven measures aimed at moderating volumes, especially in light of significant losses faced by individual retail clients trading derivatives, particularly in index options. A SEBI study covering FY22-24 has highlighted that individuals in derivatives trading incurred losses of approximately ₹61,000 crore in FY24 alone, with ₹33,000 crore attributed to prop traders and the remainder to foreign investors.
In a proactive response to these revelations, SEBI adopted six out of the proposed seven measures on October 1. The most significant of these measures, which will take effect on November 20, include raising lot sizes from ₹5-10 lakh to ₹15-20 lakh, limiting the number of weekly option series per exchange from the current five or more to just one, and increasing the extreme loss margin required for trading.
Interestingly, data from NSE, which maintains a commanding 75-80% share of the equity derivatives market, suggests that turnover began to decline even before SEBI announced these new measures, raising questions about the underlying causes of this trend.
Industry experts like Rajesh Baheti, Managing Director of Crosseas Capital, believe the tightened regulations could be a contributing factor to the decline in turnover. He noted, “The tightening could be one of the factors behind the decline in turnover, especially as the market rallied in August and September. We should monitor this month and the following as I anticipate volumes could fall by 30-35% once the new rules are implemented.”
Similarly, Rajesh Palviya, Senior Vice-President and Head of Research for Derivatives & Technical Analysis at Axis Securities, echoed these sentiments: “The tightening of rules, coupled with a 60% increase in Securities Transaction Tax (STT) on index options starting October 1, along with potential further measures such as a product suitability framework, seem to be influencing trading volumes before the new regulations come into force.”
Notably, the decline in both prop and retail turnover aligns with the increase in Nifty, which rose over 1% to 25,236 in August and an additional 2.28% to 25,811 in September, indicating a disconnect between market performance and trading activity.
SEBI has been increasingly vocal about the risks faced by retail investors involved in derivatives trading since last year. In May 2023, the regulatory authority mandated that brokers provide clear disclaimers about the risks associated with derivatives trading on their platforms. However, these disclaimers have yet to deter retail investors, who continue to incur significant losses in the sector, prompting further action from SEBI.
