Open interest’s high among retail investors. But winnings? Not quite

New Delhi: In the time you take to read this sentence, index and stock options worth some ₹10 crore would have been traded on the NSE. Trading in derivatives has increased by leaps and bounds in recent years, rising nearly 12-fold from ₹8.5 lakh crore in 2018-19 to ₹109 lakh crore in 2022-23 on the NSE alone. The average daily premium turnover of index and stock options is ₹46,444 crore on the NSE, making this segment of the derivative market bigger than even the cash market.

The worrisome part is that this sophisticated segment is drawing in people with limited knowledge and modest financial muscle. Salaried professionals, retirees, school teachers, and even housewives and students have jumped in, lured by the low brokerage and ease of trading offered by discount brokers and stock trading apps. The carpet bombing on social media for training courses in options trading has also pushed individuals into this risky segment.

With almost ₹2 crore worth of options sold every second on average, who is making money here? Certainly not individual investors, says a study by market regulator Sebi. Sebi studied trading data from the top 10 brokerages and found that 89% of individual traders had suffered losses in the F&O segment. The average loss per individual retail investor was ₹1.1 lakh during 2021-22. Meet Sunil Gupta, a Delhi-based marketing professional who started trading in options about eight months ago and has lost roughly ₹25,000 till now. Undeterred by this, he wants to carry on till he is able to recoup his losses. “The premium of options is very low so you don’t feel the pain, but it tends to accumulate over time,” says Rajat Khullar, a financial consultant whose firm does proprietary trading in options.

Experts point out that the derivative market is a zero-sum game, where institutional investors and proprietary traders can gain only when they find people like Gupta who are willing to lose. “Derivatives are meant to mitigate risk, but small investors tend to use them to acquire risks,” says Khullar.

Expert traders use sophisticated strategies to contain the risk and hedge their bets, whereas retail investors like Gupta take naked positions with no safeguard against a negative outcome. “Such random trading will not make money,” says Chandan Taparia, head of technical and derivatives research at Motilal Oswal Financial Services.

Another reason for Gupta’s continued losses is the probability skew against option buyers like him. Theoretically, there are three possible outcomes in equity market: stock prices move up, go down or remain flat. Only one of these three can be profitable for option buyers, while option sellers (or writers, as they are called) gain two out of three times. “Options are like melting ice cream. The time decay works in favour of the option writer,” says Taparia.

Hare Krishna Mohanta realised this math the hard way. The Ranchi-based retired PSU manager started out as an option buyer because “buying options required very little capital”. But he didn’t make too much money, and after a while started losing due to overtrading. “Every time I lost money, I would buy another option to cover the loss and ended up losing more,” he says. So he inverted his strategy and became an option seller.

But option selling can be tricky, and trading without enough knowledge can be ruinous. Options sold can lead to big losses if the markets move unexpectedly. The sudden market decline after the Covid outbreak in March 2020, the Ukraine crisis in February 2021 and Hindenburg report in January this year are recent examples. Within 6-7 months, Mohanta had racked up huge losses, wiping out 10% of his retirement kitty.

A wiser and more organised Mohanta now sets very small targets of 1-2% gains. He has adopted what is known as a short strangle strategy, wherein he simultaneously sells next week’s Nifty calls of strike price 200 points above the spot price and Nifty puts of strike price 200 points below the spot price.

For instance, when the Nifty closed at 17,590 on March 9, Mohanta would have typically sold calls of 17,800 strike price at ₹35 and puts of 17,400 strike price at ₹42. If the Nifty does not move above 17,800 or falls below 17,400 till March 16, he will pocket the premiums of both the put and the call options. That’s ₹1,750 per call and ₹2,100 per put. Multiply that by around 40-50 lots and you will know how traders like Mohanta are raking in lakhs every week.

But option writing requires a large capital outlay as margin money. The margin for one lot of 50 shares of Nifty is roughly ₹1 lakh. Even so, a gain of ₹1,750 is roughly a 1.75% return on the capital employed in a week. “This approach has worked magically for me. I am able to make small but consistent profits almost every week,” says Mohanta.