National Stock Exchange (NSE) Chief Ashishkumar Chauhan on Friday cautioned retail investors against trading in derivatives, advocating for equity investments through mutual funds instead. Chauhan said that Futures & Options (F&O) derivatives trading should be confined to informed investors who possess risk management skills and market comprehension.
Chauhan's warning follows concerns raised by Finance Minister Nirmala Sitharaman and Chief Economic Advisor V Anantha Nageswaran about the escalating risks of F&O trading for retail investors. In November 2023, SEBI Chief Madhabi Puri Buch also advised investors to steer clear of heavy bets on F&O.
“Retail investors should not participate in F&O trading. They should invest in equities through mutual funds,” Chauhan, Managing Director and CEO of NSE, stated at a recent event. While acknowledging the utility of derivatives, Chauhan stressed that only those with a full understanding of the associated risks and the ability to manage them should engage in such trading. He warned that individuals lacking this expertise or risk appetite should avoid derivatives.
Despite these warnings, F&O trading has surged in popularity due to its profit potential and increasing trading volumes. The segment’s massive growth is reflected in its monthly turnover, which soared to Rs 8,740 lakh crore in March 2024, compared to Rs 217 lakh crore in March 2019. The average daily turnover in the equity cash segment was Rs 1 lakh crore, while the F&O segment averaged Rs 330 lakh crore daily.
F&O trading involves contracts deriving their value from underlying assets like stocks or commodities. Futures contracts obligate the buyer and seller to transact at a predetermined future date and price, whereas 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 instruments serve purposes such as hedging risks, speculating on price movements, and arbitraging price differences. However, they carry significant risks, including leverage risk and market volatility, potentially leading to substantial losses.
A SEBI study revealed that 89 per cent of individual traders in the equity F&O segment incurred losses, averaging Rs 1.1 lakh in FY22. The study also noted an exponential increase in F&O participation during the pandemic, with unique individual traders rising from 7.1 lakh in FY19 to 45.24 lakh in FY21.
In response to these trends, SEBI recently proposed stricter norms for the inclusion of individual stocks in the derivatives segment, aiming to eliminate stocks with consistently low turnover.
Chauhan also highlighted the growing participation of retail investors in the stock market. When asked about the much-anticipated NSE IPO, he declined to comment. Regarding the upcoming Union Budget, Chauhan expressed hope for a growth-oriented financial plan.