Retail investors and the draw of options trading, and why regulators are worried

The high risks involved in options trading haven’t deterred individual investors from dabbling in the market despite regulators expressing concerns over their excessive participation in an instrument with a low scope for profitability.

Retail investors have been net buyers of index options over the past four fiscal years through 2023-24, when their volumes surged five-fold, shows aMintanalysis of data from NSE. The exchange commands 90% of the market share in such instruments.

Option buyers face limited risks, unlike option sellers, whose risks are unlimited. Besides, index options cost a fraction of futures, and option contracts expire four out of five days in a week on NSE.

“Index options are a cheap instrument (relative to futures) and you have an expiry almost every day of week, which is why retail participants have latched on to it,” said Deepak Shenoy, founder of portfolio management service firm, Capitalmind.

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For instance, to trade a Nifty futures contract a retail investor would need to place a margin of around ₹1.5 lakh with the clearing corporation, while a buyer of a Nifty 24300 call option contract expiring on 11 July would pay just ₹1,675.

Also, Nifty Midcap Select options expire on Mondays, the Finnifty on Tuesdays, Bank Nifty on Wednesdays, and Nifty on Thursdays.

The trend of retail investors buying options became more pronounced during the pandemic lockdowns as individuals with more time on their hands took to trading in the stock markets.

This has left both the Securities and Exchange Board of India and the Reserve Bank of India worried about excessive retail participation in options trading given the potential high risks involved.

Shenoy suggested that rather than denying access to a particular class of participants, Sebi would do well to increase the lot size of index options of, say, Nifty from 25 to 100, and increase the margins on option selling from ₹15,000-20000 to ₹70,000-80,000 to prevent any systemic risk.

A losing proposition

Retail investors net purchased between ₹160 billion and ₹500 billion of index options between financial years 2020-21 and 2023-24, NSE data show. In the current fiscal year through May, they have net purchased ₹110 billion of index options.

The number of active individual investors participating on NSE’s equity derivatives segment rose from about 6.7 million in FY23 to 9.57 million in FY24.

Though NSE hasn’t segregated how many participated at least once in a year on index options or index futures, analysts such as Rajesh Palviya of Axis Securities Ltd say a large number would have participated in the index options segment.

Also read | Why Sebi and RBI want retail investors to stay away from derivatives

But option buyers generally lose money, as the probability of options turning profitable is low, say analysts.

“Retail tends to buy cheap out-of-the-money options whose chance of becoming in-the-money are pretty low,” said Palviya, senior vice president and head–technical and derivatives research, at Axis Securities.

“More often than not, they are unaware of options pricing terminology like delta and theta, which reveal the probability of the position yielding profit to them,” he added.

NSE data show that the counterparty to retail traders tends to be proprietary traders, who are brokers trading on their own account.

In 2023-24, proprietary traders net sold index options worth ₹245 billion, exchange data show. In FY25 (Apr-May), they net sold index options worth ₹48 billion.

Delta and Theta

Delta measures the change in the price of an option for every change in the price of an underlying index such as the Nifty or the Bank Nifty.

Theta measures the loss in the value of an option for every day that it’s held.

A call option with a delta of 0.3 means there is a 30% chance of it turning profitable.

Out-of-the-money here refers to an option whose price is higher (in the case of a call) or lower (in the case of a put) than the current market price of the underlier.

In-the-money for a call is when the option price is lower than the current market price of the underlier, while for a put is when the option price is higher than the current market price.