Equity futures and options - Road to quick wealth?

SEBI released a report this month, featuring their analysis on the performance of individual traders in the equity futures & options (F & O) segment for the financial years 2019 and 2022.

It makes for interesting reading.

What are futures and options?

Investopedia defines them as "financial derivatives used to speculate on market changes or to hedge risk".

Whereas an option gives the buyer of the option a right to buy or sell the underlying security at a specific price during the life of the contract, a futures contract obligates the buyer to purchase a specific asset and the seller to sell that asset at a specific future date.

What are the findings from the SEBI report on equity F & O?

Sebi has analyzed the performance of the individual traders (as opposed to institutions) for the financial years 2018-19 and 2021-22 i.e. pre and post-covid.

The data for F.Y. 2022 was taken from the top-10 brokers who comprise 2/3rds of the overall individual turnover in the equity F & O segment.

SEBI classified active individual traders as those trading a minimum of 5 times in the financial year.

If you want the full report you can download it from the SEBI website.

How many of the active traders made a profit in the equity F & O segment?

SEBI defines active individual traders as those who traded at least 5 times in this segment in FY 19 or FY 22. In this analysis trimmed does not include the "outliers" i.e. the top 5% or bottom 5% active individual traders making profit or incurring losses.

• Only 1 in 20 or 6% of the active "trimmed" traders made a profit while 94% or nearly 19 of 20 active traders made a loss in FY 2022.
• Average net trading loss suffered by the 94% active traders was nearly ₹50,000 in FY 22.

Why was the average loss suffered less in FY 22 ?

Does this mean the traders are getting better and hence suffering "less losses"?

There is probably a simpler answer.

More than six times as many individuals traded actively in FY22 compared to FY19.

Which age groups make up the active trading universe for this report?

75% of individual traders in FY22 are from the 20 to 40 age group. The biggest increase in active individual traders in the equity F & O segment has been in the 20-30 age group whose share has gone up by more than three times.

What are the risks in equity options and futures?

Options Trading Risks:

• Limited Lifespan: Options come with a limited lifespan and if the price of the underlying asset doesn't move in the direction a trader was hoping for, the option could expire worthless, resulting in loss of the invested money.
• Complexity: Options can be complex, making it hard for individual traders to make informed decisions and leading to higher risk of losses.
• Volatility: The Indian stock market can be volatile and unpredictable, which can impact the price of options and result in losses, even for the most well-informed traders.
• Limited Control: Once you purchase an option, you have limited control over the outcome, resulting in potential losses, even with a smart investment decision.

Example:

• A trader buys a put option on Reliance Industries stock, expecting a decrease in the stock price. But the stock price rises, resulting in the option expiring worthless and again the trader loses the invested money.

Futures Trading Risks:

• Large Losses: Futures trading comes with the risk of large losses if the price of the underlying asset moves against the trader.
• High Investment: Futures contracts often involve large amounts of money, making it difficult for individual traders to manage.
• Market Volatility: The stock market can be volatile, impacting the price of futures contracts and leading to losses, even for well-informed traders.
• Lack of Knowledge: If a trader lacks the necessary knowledge, they may make poor investment decisions, leading to potential losses.

Example:

• A trader buys a futures contract on HDFC Bank, expecting the stock price to increase. Instead the stock price decreases, resulting in the trader incurring a large loss.

What does this report mean for individual traders or those looking to become active traders in equity F & O?

Trading or active trading in equity F & O is not a route to quick wealth. As the SEBI report reveals, 94% individuals who actively traded have incurred average losses to the tune of ₹60,000 or more while the remaining 6% profit makers have made an average profit of around ₹4,000.

The average share of transaction costs for the individual loss-makers was 28% of their losses.

Unfortunately, this report does not provide details of the time lost doing active trading in derivatives by individuals or the scale of stress suffered by them while incurring these losses or trying to overturn them.

For the average trader, this activity is a losing proposition.