Why is F&O trading volume a macro-economy concern?

In a recent interview, Security and Exchange Board of India (SEBI) chairperson Madhabi Puri Buch said that the increasing Futures and Options (F&O) trading volume is a macroeconomic concern. What does it mean, and why is that so? Before we answer these questions, we want to cover the basics so you understand the issue better.

What is F&O trading volume?

F&O trading volume refers to the total number of future and options contracts traded on a particular day (week or month). Suppose on a given day, 1,000 Nifty 50 futures contracts are bought and sold in the market. It means that the futures trading volume for Nifty 50 on that day is 1,000 contracts.

Here is why knowing F&O trading volume is important:

Market Liquidity: High volume indicates a liquid market (the present scenario), making it easier to enter or exit positions.
Market Sentiment: Volume also provides clues about investor sentiment. High volume with rising prices suggests bullishness, while high volume with falling prices might indicate bearishness.
Volatility: Increased volume coincides with higher volatility, which can present both opportunities and risks.

Current scenario and concerns of F&O trading volume

In June 2024, the Reserve Bank of India (RBI) released its bi-annual Financial Stability Report (FSR). One of the concerns highlighted in the report was the sharp increase in derivative (F&O) market trading in India.

In FY24, the equity derivatives segment saw a jump of 42.8% in the trading volume, with trading volume increasing to 95.7 lakh contracts, up from 65 lakh in FY23. Also, turnover in index options in premium terms has reached Rs 140 lakh crore in 2024 compared to Rs 4.5 lakh crore in 2018. The overall turnover in the derivative segment increased to Rs 500 lakh crore in 2024, a sharp jump from Rs 210 lakh crore in 2018. The individual investor count has gone up from 2% to 41% in the same period.

The sharp increases in F&O activity are challenging for those retail investors who do not have robust risk management practices. Since F&O trading is complex and most investors are not equipped to understand it, it is essential to protect investors' interests.

How is F&O trading a macroeconomic problem?

The rising F&O trading volume has become a macro concern - the SEBI chairperson said recently. What does it mean? Traditionally, Indians put their savings into safer asset classes like fixed deposits. Then, they move to wealth-building options like mutual funds.

With the growth of F&O volume, the financial savings from Indian households are going into speculative bets, and the Indian youth is losing tonnes of money. The issue has gone from a micro issue (at the individual investor level) to a macro level. Here are more points to support the same:

Market Volatility: Excessive F&O trading can amplify market volatility, leading to price swings that do not necessarily reflect underlying economic fundamentals.
Systemic Risk: Large-scale losses in the F&O segment can have ripple effects on the broader financial system.

Effect of F&O trading on micro and macro economy

Below are the positive and negative impacts of F&O trading on micro and macro economies:

Microeconomic Impact

F&O trading enhances market liquidity, enabling easier buying and selling of underlying securities.
Derivatives help in efficient price discovery, reflecting market sentiments accurately.
F&O instruments allow businesses to manage price risks, leading to better financial planning.
Excessive speculation can lead to increased volatility, impacting individual investors and businesses.
The use of leverage in F&O can lead to significant losses for individual traders.

Macroeconomic Impact

F&O trading contributes to efficient price discovery, reflecting economic fundamentals accurately.
Excessive speculation and leverage can pose risks to financial stability.
F&O trading can divert resources from productive investments to speculative activities.
The government earns revenue through taxes on F&O trading profits.

Measures SEBI is planning to undertake to protect the investors

In July, SEBI, in a consultation paper, proposed measures to protect the investors. Here are measures that SEBI is planning to implement:

Increasing minimum contract size
Upfront collection of option premiums
Intra-day monitoring of position limits
Rationalisation of strike prices
Removal of calendar spread benefit on expiry day
Increase in near-contract expiry margin

These measures are aimed at increasing investor protection and promoting market stability in derivative markets.

Before you go

Without any doubt, the F&O trading volume has increased in recent quarters. Most investors are losing money in the trading, and there are multiple reasons for it - lack of education, no risk management system in place, etc. SEBI has addressed the issue, which is great news for the overall market, and the steps highlighted above will surely protect the investors. On the downside, the stock exchanges will be affected since a large part of their revenue comes from options trading (NSE to be more impacted compared to BSE).