Rise in options trading from small centres worries Sebi

The Securities and Exchange Board of India (Sebi) is getting uneasy about the rise in index options trade by investors from smaller centres. Lured by the possibility of high returns, investors from the retail category in smaller towns and cities have been increasing their exposure to these options since the beginning of the year.

The regulator said the low levels of financial literacy and investor awareness was the main reason for rise in retail participation in the derivatives segment. "In smaller centres, people have started trading in index options, which is not suitable for them. They are being encouraged even though they don't have much knowledge about these products. They are being lured by the gains," said Rajeev Kumar Agarwal, whole-time member, Sebi, at a financial literacy seminar.

Average monthly trading turnover in index options in November stood at 84 per cent of the total trades in the market, up from 77 per cent in January.

Index options are instruments where investors and traders can take exposure to stocks in an index for diversification and better returns.

Such trades, while providing higher returns, also involve higher risks for investors.

In options trading, investors and traders only need to pay an options premium, much smaller than the contract value. In options shorting, the trades can generate very high returns but in case of a fall in the index value, the loss is only to the extent of the amount paid as options premium.

In the case of options writers, the risk of loss is unlimited. However, the potential to make profits is limited. This is the segment which is seeing higher traction among retail participants, sector officials said.

"Since Nifty margins at this point are lower than stock margins, options writing is becoming much more popular among retail and high net worth investors (HNI). Earlier, options writing was largely done by savvy HNIs or foreign institutional investors, who understood this segment quite well," said the head of derivatives of a domestic brokerage, who did not wish to be named.

The rise in trading in index options indicates a rise in speculation in the market, ill-advised for retail investors who should be looking at long-term investing, sector officials said.

Market intermediaries in smaller town's and cities have been known to be encouraging new investors to explore this route to advance their businesses. Concerned by this trend, the regulator has boosted its investor awareness initiatives, with a particular focus in smaller centres, where the practice of misleading investors is more rampant. Regional offices of Sebi have a dedicated classroom where such investor education programmes are routinely held, said Agarwal .

"Not just the investors, but the intermediaries also need to be educated. We need to tackle the issue of financial ignorance from all sides to end such malpractices," said Agarwal.