Reuters Report: Is derivatives trading a game of chance or a calculated risk?

Lea Hogg July 23, 2024

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Reuters Report: Is derivatives trading a game of chance or a calculated risk?

In a recent report by Reuters, it was revealed that a surge in derivatives trading in India could be attributed to a ‘gambling instinct’. The report, released by the finance ministry, suggested that the sharp increase in derivative trading among Indian retail investors is likely driven by the allure of potential outsized gains, which cater to human’s gambling instincts.

The annual Economic Survey, presented in parliament by Finance Minister Nirmala Sitharaman, (pictured above), highlighted these considerations as the likely driving force behind the active retail participation in derivatives trading. The report cautioned that any significant correction in the stock market could deter young investors.

Since the COVID-19 market lows in March 2020, benchmark equity indexes have seen a surge of more than 200 percent, largely attributed to an influx of retail traders in the derivatives market. The share of derivatives trading volumes by retail traders has skyrocketed to 41 percent this year, up from just 2 percent in 2018. This has propelled India’s monthly notional value of derivatives traded to a worldwide high of 9,504 trillion rupees ($113.60 trillion) in May.

However, the report also warned that derivatives traders globally tend to lose money for the most part, and retail investors could face even more considerable losses in the event of a significant market correction. The behavioral response of investors to such losses could lead to a feeling of being ‘cheated’ by unseen, more considerable forces, potentially causing them to withdraw from capital markets for a long time.

Analysts have suggested that the government may consider raising the transaction tax on derivatives to temper the frenzy and also consider adjustments to long-term tax rules for equity investments.

Potential market instability

The Economic Survey also issued a caution against the rise in the market capitalization of listed Indian companies. The market capitalization of companies listed on the NSE, India’s largest exchange, stood at $5.29 trillion as of July 22, up from $3.59 trillion a year ago. In March alone, the market capitalization-to-GDP ratio had risen to 124 percent – higher than other emerging market economies like China and Brazil – up from 77 percent five years ago.

The survey results clearly indicated the need for caution, stating that if equity market claims on the real economy are excessively high, it could be a sign of market instability rather than market resilience. The report does not always provide signals for likely budget announcements, but it does offer valuable insights into the current state of the market.