Hedge funds take great pains to hide their inner workings. So a recent court case in which Jane Street sued two former employees and Millennium Management, another fund to which they had jumped ship, was immensely pleasing to the firm’s rivals, since it offered a rare view into one of the industry’s giants. Among the revelations: Jane Street’s “most profitable strategy” did not play out on Wall Street, but in the unglamorous Indian options business, where the firm last year earned $1bn.
Hedge funds take great pains to hide their inner workings. So a recent court case in which Jane Street sued two former employees and Millennium Management, another fund to which they had jumped ship, was immensely pleasing to the firm’s rivals, since it offered a rare view into one of the industry’s giants. Among the revelations: Jane Street’s “most profitable strategy” did not play out on Wall Street, but in the unglamorous Indian options business, where the firm last year earned $1bn.
This news has drawn attention to India’s options market, which is staggeringly large. According to the Futures Industry Association (FIA), a trade body, the country accounted for 84% of all equity option contracts traded globally last year, up from 15% a decade ago. The volume of contracts last year touched 85bn and has more than doubled every year since 2020 (see chart). Most of the frenzy is focused on the National Stock Exchange (NSE), which handles more than 93% of the transactions.
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This news has drawn attention to India’s options market, which is staggeringly large. According to the Futures Industry Association (FIA), a trade body, the country accounted for 84% of all equity option contracts traded globally last year, up from 15% a decade ago. The volume of contracts last year touched 85bn and has more than doubled every year since 2020 (see chart). Most of the frenzy is focused on the National Stock Exchange (NSE), which handles more than 93% of the transactions.
The options boom is propelled by the rapid growth of India’s stockmarket. In January it overtook Hong Kong’s to become the fourth-largest in the world. The Nifty 50, NSE’s benchmark index, is hovering near an all-time high. In 2019 the NSE had 30m registered retail investors. By March that number had trebled.
Most trades involve equity-index options—a security that gives the holder the right to buy an index at a given price, called the “strike price”, when the contract expires at a future date. These are often used to place bets on the direction of an index for a small fee. If the strike price for a bullish option is far above the current index level, the cost of the option, called “the premium”, is a tiny fraction of the value of the index. If the index climbs above the strike by expiration, the bet pays off. Otherwise investors lose the premium. Most Indian equity-index options are risky short-dated contracts of a week.
The swift rise of India’s options market has parallels with America’s meme-stock craze. Covid-19 spawned a generation of Indian investors who turned to day-trading in order to escape boredom. This coincided with the rising popularity of apps, such as Groww and Zerodha, which made trading cheap and easy for small investors. For those with an appetite for speculative trades, choices are limited. Short-selling stocks—a way to bet on a falling share price—is not easy in Indian markets. High taxes and government scrutiny have deflated interest in cryptocurrency trading. That leaves equity options as the only outlet for those seeking quick profits.
So-called finfluencers, social-media figures who promote options trading as an easy way to get rich, are pouring fuel on the fire. Many sell courses that teach trading strategies. They flaunt luxury cars and extravagant houses in order to demonstrate their success and attract customers. And the lure of an outsized pay-off can be hard to resist, especially for newbies.
The Securities and Exchange Board of India, a regulator, estimates that nine in ten retail investors lose 125,000 rupees ($1,500) a year on average—equivalent to six months’ salary for a typical urban Indian. It has warned about the risks and is considering rules to clamp down on unregistered financial advisers. In October it barred Mohammad Nasiruddin Ansari, a popular influencer on social media, from securities trading and ordered him to refund $2.1m in customer fees. Although trading platforms have also tried to alert users to the risks by displaying warnings and offering tools that simulate market movements, Nithin Kamath, head of Zerodha, admits the message “does not really stick” until a user loses money.
More sophisticated institutions stand to benefit from the boom. Jane Street’s profits suggest that hedge funds and high-speed trading firms are doing well in India’s low-value, high-volume market. Besides Jane Street, other trading houses, such as Citadel Securities, IMC and Tower Research, have been expanding in India. The frenzy has also enticed local funds that are competing with global firms.
A veteran Indian broker points out that exchanges, trading firms and the government, which pockets taxes on option trades, benefit from the boom. The average retail investor, on the other hand, is gambling “for a chance to become Ambani”, he notes, referring to India’s richest man, Mukesh Ambani. The real Mr Ambani is eyeing a different route to stockmarket wealth. On April 15th Jio Financial Services, a spin-off from Reliance Industries, his conglomerate, announced a venture with BlackRock, an American private-equity giant. The pair will establish a wealth-management and brokerage outfit. At least one Ambani is set to profit from India’s thriving equity market.
© 2024, The Economist Newspaper Ltd.
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