India's F&O segment of the derivatives market has grown spectacularly in recent years. Yet there is a peculiar trend: just one out of every five players only deals in F&O. What follows is an investigation into the F&O segment, revealing the reasons why most players diversify, the risks associated with it, and the reasons behind regulatory shifts.
Introduction to F&O Trading
Futures and Options are financial derivatives whose value is drawn from an underlying asset, be it stocks, indices, or commodities. While futures compel buyers and sellers into a contract to trade at a set price on a specified future date, options give the holder the right—but not the obligation—to buy or sell an asset by a specific time limit. These instruments are well-liked among traders for speculative and hedging purposes because of their high returns potential with comparatively low capital outlay.
Even though they are attractive, F&O trading is fraught with risks of leverage and market movements. The Securities and Exchange Board of India (SEBI) has continuously warned retail investors regarding these risks, stressing the need to understand derivatives prior to joining in.
The Dominance of Options Over Futures
According to a recent study by SEBI, 99.3% of F&O segment traders traded options at least once during FY24, whereas only 5.9% traded futures. Additionally, 94.2% traders traded only options—a trend spurred by lower charges and less capital requirements as opposed to futures.
Futures and options trading have emerged as the first choice of retail investors because of their ease of access as well as perceived profitability. Weekly expiries of indices such as Nifty as well as Bank Nifty have even further contributed to this trend by allowing repeated speculation opportunities.
Why Most Traders Shun Exclusively Trading F&O?
There are certain reasons why most traders avoid exclusively trading F&O:
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High Loss and Risk Rates: SEBI's report pointed out that 91% of retail traders made losses in FY24, with participants below the age of 30 experiencing even higher loss rates (93%). The increased risk posed by leverage tends to prompt traders to seek safer investment options in addition to F&O trading.
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Regulatory Shifts: SEBI's recent initiatives to curb excessive speculation have had a major impact on retail participation in derivatives. The changes resulted in trading activity decreasing by 20%, forcing many traders to rethink their strategies and spread their investments.
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Algorithmic Trading Advantage: Institutional players such as Foreign Portfolio Investors (FPIs) and proprietary houses control profits in the F&O segment via algorithmic trading. Retail investors, being deprived of advanced tools, tend to suffer disadvantages while competing with algorithmic strategies.
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Accessibility of Other Investment Options: Mutual funds and equity investments provide relatively stable returns with lower risk profiles. Most traders use these alternatives in addition to derivatives trading to diversify their portfolios.
Geographical and Demographic Trends
The SEBI study also brought to light interesting facts regarding the geographical and demographic pattern of F&O traders:
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Urban vs Rural Participation: Tier I cities have a higher contribution to overall turnover but lower losses than smaller towns (B30 cities), where traders experience disproportionately higher financial losses. This indicates that urban traders enjoy greater access to resources and market information.
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Youth Participation: Traders below 30 years old now make up 43% of the participants—a rise from 31% in FY23. Yet this group is also more likely to incur losses with less experience.
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Gender Dynamics: Female trading participation in F&O has reduced in the last two years, falling from 14.9% in FY22 to 13.7% in FY24. Interestingly, women incur lower average losses compared to men, reflecting a conservative attitude towards derivatives trading.
Risks of Exclusively Trading F&O
Exclusively trading in F&O can be financially risky because of a number of inherent risks:
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Leverage Amplification: Although leverage enables traders to manage big positions with little capital, it also magnifies losses during negative market movements. For example, even a small price movement can destroy a whole margin.
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Transaction Costs: Exorbitant brokerage commissions and taxes can easily devour profits, rendering constant profitability difficult for individual traders.
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Market Volatility: The erratic movement of stock prices can cause abrupt losses, especially for those highly price-decay sensitive options contracts nearing expiration dates.
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Psychological Pressure: The fast-moving dynamics of derivatives trading tends to create decision-making under emotional pressures, and therefore errors are more likely to be made.
Regulatory Measures and Their Impact
In order to limit risks for retail investors, SEBI has introduced strict regulations that aim to minimize speculative activity in the derivatives market. These include increased margin requirements and intraday leverage restrictions. Although these reforms have checked excessive speculation, they have also resulted in a fall in retail participation by more than 20%, indicating a change towards more conservative investment behavior.
Conclusion
The reality that fewer than one in five derivative players deal only in F&O highlights the nature and risk of these products. Although they present hedging and speculation opportunities, their risky nature requires deep comprehension and disciplined application.
Retail investors should carefully consider the advantages and disadvantages of going exclusively into F&O before actually doing so. Having a diversified portfolio with more conservative investments could help to hedge risks while providing long-term financial security.
Finally, derivatives trading success depends on knowledge, strategy, and risk management—a lesson reiterated by SEBI's research on trader losses and profitability patterns. As India's financial environment continues to change, wise decision-making will continue to be essential in coping with the pitfalls of F&O trading successfully.
Source: Investopedia, Motilal Oswal, Business Standard, Nagpur ICAI, Capital Mind, Moneysukh, HDFC Sky
