 "Ashish Gupta")
Domestic equity markets have become a huge draw for speculators with the derivatives market clocking nearly 400 times the volume of the underlying cash market.
In a note titled ‘Gamification of Indian Equities’ by Axis Mutual Fund’s chief investment officer Ashish Gupta has highlighted several data points, which throws the spotlight on excessive speculative activity.
The note underscores that the number of active derivatives traders in the domestic markets have jumped 8 times to 4 million from less than half a million in 2019.
In comparison, in the cash market, the number has swelled from 3 million to 11 million during the same period. The total derivatives volumes have risen to over $4.3 trillion per day — which is 1.2 times the market cap of underlying companies and over three times the free-float traded every day.
Further, the derivative volumes are more than 400x higher than the underlying cash market and 900x of delivery-based trading volumes, the Axis MF note says.
Globally, the derivatives markets are more popular than the cash market, however, the volumes are still at a reasonable 5-15 times their cash market volumes.
The derivatives were conceptualised as a tool for hedging one’s cash market exposure.
However, they are far more popular than the cash markets. Axis MF predicts the popularity of the derivatives market to increase even more as exchanges re-align the expiry day for various contracts and reduce the contract sizes.
“Change in contract structure, leverage combined with the ease of onboarding and interface of the new generation trading apps has triggered gamification of this market,” says Gupta.
He highlights data points that point to hyper speculation. For instance, the open interest at the end of the day is only a per cent of the daily traded volumes, i.e. only 1 out of 100 contracts are carried forward to the next day. Further, retailers option traders average holding periods of less than 30 minutes.
This came even as the odds were stacked up against derivative traders.
“In fantasy sports, the take rate of the pot is 15 per cent. For every Rs 100 put in by the participants, get Rs 85 back. However, the skew is opposite in derivatives, with only 15 per cent of the pot coming back to retail,” the Axis MF note points out.
Worryingly, the derivatives market continues to attract a lot of young investors that too from smaller cities.
“The average age of an equity retail investor is 35 years, whereas those with digital discount brokers is 29 years, similar to 31 years for online gaming companies. Notably, half of the new customer additions are below 25,” the note says.
The derivatives market comprises futures and options, with contracts available on index and individual stocks. However, the pie is dominated by index options, which account for 98 per cent of total derivative volumes.
Gupta says the introduction of shorter duration in options has effectively “sachetized” trading, reducing the capital needed to take on similar risks.
“Weekly options are cheaper compared to monthly contracts, and buyers gain exposure to the full notional value by paying only 0.5-5 per cent for the same,” he points out.
Gupta explains that while on the one hand, the derivatives market has a useful economic function wherein risks can be transferred from those who do not want it to those who want it. It also provides an additional liquidity in the market, beyond what is available in the cash markets.
However, given the size of the Indian derivatives market vis-à-vis the underlying cash market, one needs to be careful, he warns.
“The outsized derivatives can itself be a source of additional macro and market risk, we have seen this in global cases with CDS and derivatives contracts. Black swan events and resultant spike in volatility in particular can drive exaggerated moves in stock prices and result in market dislocation,” Gupta adds.
