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India Plans Stricter Regulations for Derivatives Market Amid Surge in Trading Activity

India is poised to introduce stricter regulations in its equity derivatives market to curb risks associated with the explosive growth in trading activity, particularly in options contracts. This move comes as the country’s derivative market has surged to become the world’s largest by trading volume.

The aim is to protect small investors from potential losses and preempt broader financial instability, though it may reduce profitability for trading firms and discount brokers.

Over the past few years, India has seen a significant increase in retail participation in derivative trading, driven in part by the accessibility and perceived profitability of options trading. The turnover in Indian index options contracts skyrocketed to $135 billion in March, a stark increase from just four years earlier.

The number of active derivative traders has also surged to four million, up from less than half a million in 2019, indicating a widespread interest in speculative trading.

India Plans Stricter Regulations for Derivatives Market Amid Surge in Trading Activity

India Plans Stricter Regulations for Derivatives Market Amid Surge in Trading Activity

Despite the substantial trading volume, India’s National Stock Exchange still lags behind more developed markets in terms of trade value. However, the impact of losses on individual traders has been severe, with a Securities and Exchange Board of India (SEBI) report revealing that nine out of ten traders in futures and options incurred losses over a recent 12-month period.

The regulatory changes under consideration include tightening margin requirements for options contracts and mandating more detailed disclosures. These measures are partly a response to unintended consequences of previous regulations, such as SEBI’s 2020 margin norms which inadvertently incentivized traders towards options trading.

The rise of discount brokers like Zerodha and Angel One, which offer significantly lower trading fees compared to traditional brokerages, has further fueled retail participation. These firms have reported substantial profit growth, contrasting with declines seen in more established financial institutions’ broking units.

In light of potential risks to financial stability posed by unchecked speculative trading, Indian regulators are moving to introduce written tests for individuals wishing to trade derivatives, aimed at educating and qualifying retail investors. This approach reflects a broader strategy to make derivative trading less speculative and more informed, thereby reducing systemic risks to India’s financial system.

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