Futures and options (F&O) have been in the limelight for the wrong reasons in recent times. But here is some good news.
The F&O-to-cash volume ratio, which was trending sharply upwards since 2021, is now at its lowest since November 2022. The ratio began losing steam in April 2023. Does this mean traders are becoming more cautious and are prioritising cash trades? Not necessarily.
Bull market draws participants
Powered by the booming equity market, the cash market has been witnessing strong growth, especially since the beginning of the latest leg of the rally in mid-2023. “The volume in the cash segment grew especially after the mid- and small-cap indices started outperforming the benchmarks. But on the other hand, when markets go down, F&O volumes can go up because of hedging demand, taking the F&O-to-cash volume ratio higher,” says Deepak Jasani, Head – Retail Research, HDFC Securities.
Since March 2023, the Nifty-50 has appreciated 43 per cent whereas Nifty Midcap 50 and Nifty Smallcap 50 have advanced 92 and 115 per cent, respectively. So, as trading volumes in mid- and small-cap space increased, the ratio dropped. But it again went up, hitting a peak in October 2023 when the market witnessed a brief correction.
However, in the first half of 2024, cash market volumes grew 118 per cent compared to the same period last year, whereas the F&O segment volumes grew at a lower 64 per cent.
Limited impact
Even as the ratio has come down because of higher cash market volumes, F&O volumes have continued to expand. Concerned by this, the Budget raised STT (securities transaction tax) for futures, from 0.0125 per cent to 0.02 per cent; for options, it was increased from 0.0625 per cent to 0.1 per cent.
However, in absolute terms, the rise in cost for traders is marginal and it might not stop retail participants. “Liquidity providers like proprietary traders and HFTs (high frequency traders), who deal with large volumes, can be impacted by the STT increase. But the retail traders might not face a big effect,” says Nithin Kamath, Founder & CEO, Zerodha.
So, in case the volume drops, it could come from lower activity from above-mentioned players, but not retail participants. This means that it is not the Budget move, but SEBI’s future course of action, which holds the key.
All eyes on SEBI
The market regulator has been considering some more measures to clamp down F&O volumes. There have been reports of SEBI mulling an increase in derivatives lot size from ₹5 lakh to ₹25 lakh, restrictions in weekly options expiries, setting higher margin obligations, etc. These measures are stringent than the Budget move, and even if the recent STT increase fails to reduce the volume, the above measures, if implemented, can give the regulator the desired result.