Observers are likening trading in futures and options to gambling or betting on horses. Exchanges regulator SEBI has come out with a consultation paper that aims to rein in such losses at the retail investor level.
In an editorial last week, our group publication businessline pointed out that derivatives trading, like gambling, is addictive.
On July 30, SEBI chairperson Madhuri Buch said that households were losing ₹60,000 crore annually due to losses in F&O trading. I will repeat that figure - ₹60,000 crore in annual losses. Not one-time, not corporates. These are households who collectively lose such an amount in one year!
A couple of days later, SEBI board member Ananth Narayan pointed out in a speech that about 90% of such trades resulted in losses for retail investors. What are futures & Options? Where and how did they originate?
Futures & Options are now seen as sophisticated instruments on the stocks and commodities exchanges. However, the concept started several hundred years ago when farmers wanted to lower the risk of crop prices falling by the time of harvest. So they secured a contract ahead of time that would help them sell at a fixed price. They also executed contracts that gave them the option to sell at a certain price from the time of sowing to the time of harvest. The options offer choice – they could sell, or not sell at a future date, depending on how prices moved.
Nowadays, derivatives are meant to help in the price discovery of an asset and, as importantly, spread your risk of loss. For example, assume someone owns stocks and if a major development like vote counting for general elections were to take place.
Depending on the results, the prices may move up or down. To hedge their risk and at the same time not willing to sell the stock, investors may use derivatives to lower their risk of loss if the original stocks they owned dipped in value on results day.
Presentation: K. Bharat Kumar
Production: Shibu Narayan
Video: Thamodharan B.
