Editor’s Note
Dr. Mahuya Basu teaches Finance at Globsyn Business School – one of the best business management colleges in Kolkata. With over 22 years of experience in teaching and academic administration, Dr. Basu’s last stint, in the capacity of a faculty and Head of the Department was at Footwear Design & Development Institute (FDDI), Kolkata. She was earlier associated as a faculty member in ICFAI National College and led several learning sessions for students in the field of Financial management, Economics and Business Research Methods, etc. Dr. Basu has several conference papers and journal publications to her credit, and has co-authored two books. One of her research papers has been awarded as the Third Best Paper from industry and academia in the International Conference of Nirma University; NICOM.
Over the last 40 years, ‘derivative contracts’ have taken a central role in finance. Financial institutions, fund managers, and corporate treasurers frequently engage in various derivatives trading both in exchange traded and over the counter platform. A derivative is a financial instrument whose value is derived from underlying variables, often the prices of traded assets. For example, a stock option’s value depends on the stock price, but derivatives can also be based on diverse variables like commodity prices or even weather conditions.
Financial ‘options’ play a significant role among all traded derivative contracts. A financial option contract is a derivative instrument that grants the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specified period. The option to buy is commonly known as ‘call’ and option to sell as ‘put’. The predetermined price is termed as strike and the specified period after which the contract expires, is commonly known as expiry. The first financial option contract in India was traded way back in 2001, when the National Stock Exchange (NSE) launched index options based on the Nifty 50 index. Today, NSE has emerged as the world’s largest derivatives exchange by trading volume for five consecutive years, reflecting the increasing dominance of derivatives in global financial markets including India.
The primary focus of promoting financial derivative contracts has always been risk management. The function of a financial derivative is to reduce risk and not to gain speculative profit. Any financial derivative instrument can be used for reducing or transferring risk in order to achieve a more stable cash flow. This activity is commonly known as hedging. However, over the time period, speculation surpasses the hedging activities in many folds in derivatives, mostly in the option market. The same is reflected in the exponential increase of trading volumes in the derivatives segment over recent years. For instance, in India the overall derivative turnover jumped from Rs 210 lakh crore in FY18 to Rs 500 lakh crore in FY24. The participation of individual investors in index options also saw a significant rise from 2% in FY18 to 41% in FY24. Both SEBI and the Reserve Bank of India (RBI) have expressed concerns about the impact of such speculative trading habits on broader financial stability. SEBI Chairperson Madhabi Puri Buch has pointed out instances of retail investors borrowing money to place bets in the derivatives market, which could lead to systemic risks if not managed properly. Exprts have even highlighted the alarming statistic that nine out of ten small investors lose money in futures and options (F&O) trading.
Concerned with the abnormal surge in the speculative activities in the derivative market, especially option market, SEBI recently has set up an expert group. The group has proposed seven measures to curb speculation and enhance investor protection in the options market in their report released on July 8, 2024. These measures address regulatory challenges and aim to protect small investors from the risks associated with speculation in index and stock option trading. These proposals include limiting the number of weekly options and strike prices, eliminating calendar spread benefits on expiry day, requiring upfront collection of option premiums, enhancing intra-day monitoring of position limits, increasing lot sizes, and hiking margin requirements on contract expiry. These measures aim to strike a balance between investor protection and maintaining the liquidity and functionality of the options market. The proposals will be reviewed by SEBI’s Secondary Market Advisory Committee for final decisions.
Commenting on the proposal, Naresh Pachisia, Senior Vice President of Bharat Chamber of Commerce and Managing Director of SKP Securities Ltd., said that SEBI’s intent was correct as unchecked retail participation in options can lead to harmful speculation. He has also emphasized on the need for investor protection to shift focus back to wealth creation rather than addictive speculation. On the other hand, imposing severe restrictions on the market movement would negatively affect the liquidity and thereby long-term investors’ ability to hedge their portfolios.
Whether SEBI would impose the restriction or not is yet to be decided. However, the immense ability of financial markets to impact millions of common lives is eminent. The societal impact of the functioning of the financial market is also an area to focus on in future. Due emphasis on both the functioning of financial markets and risk management strategies are given in Finance specialisation courses of Globsyn Business School. In a dynamic field like Finance, where the market reality changes every day, focus on recent development and policy aspects are also discussed in-depth on a regular basis both in classroom and through asynchronous mode.
Dr. Mahuya Basu
Faculty – Marketing
Globsyn Business School