Futures and Options (F&O) is part of derivative trading in the stock market that allows a trader to enter into a contract for buying or selling an underlying at a pre-set price and date.

The underlying asset can be shares, indices, commodities, or currency. F&O trading is done to benefit from price movements without necessarily owning the underlying asset and to hedge existing positions in the market.

Until a few years ago, F&O trading used to be undertaken only by institutional and seasoned traders. However, in recent times, retail participation in this market has increased significantly, which has had a varying impact.

The question is, to what extent has retail trading increased in this market, and does it actually impact the F&O market? Let’s find out.

Increased retail participation in the F&O segment

Over the past several years, there has been a notable shift in the behaviour of retail traders, and their keenly growing interest in the derivatives segment is quite evident. Retail traders have shifted their preferences to look for high-risk assets to receive higher returns.

For example, retail traders and proprietary traders’ participation in derivatives has grown from 8 lakhs in FY19 to approximately 45 lakhs in FY23. Additionally, the number of retail traders trading within derivatives reached 7.2 million from 6.7 million in April–Nov 2023, respectively, from only 5.1 million traders in FY22.

In FY24, the average derivatives turnover increased from ₹154 trillion in 2023 to ₹299 trillion, an approximate increase of 94%. If we look at separate futures and options markets, over the last 7 years, the daily average future turnovers grew at a CAGR of 9.1%, while the equity options premium turnover grew by 63.4%.

This shift has increased broader index prices. For example, the Nifty 50 share price has reached 22,200+ in May from 11,000 in 2019. In the same way, the Sensex share price has crossed the 74,000 level this year.

Given this, the National Stock Exchange (NSE) also proposed extending the derivative trading hours by adding another trading session in the evening, from around 6 pm to 9 pm.

However, this proposal has been rejected by SEBI, but it still clearly indicates that increased participation from retail traders has an impact on the overall F&O market. In the next section, we've clearly mentioned how retail participation impacts the market.

Can retail traders truly impact the F&O market?

As per Nirmala Sitharaman's recent statement, retail participation has the potential to impact the F&O market, especially when retail traders make unchecked trades. These could easily trigger challenges for the market.

That said, retail participants are important for the F&O market. Retail participation leads to market liquidity and resilience, along with volatility. Below are certain positive and negative impacts of retail participation on the market.

Positive Impact of Retail Participation in the F&O Market

• Increased Market Liquidity: Retail participation significantly increases the market's liquidity and facilitates the buying and selling of assets. In simple words, when a large number of retail traders trade in smaller quantities, bid-ask spreads reduce.

• Financial Democratising: Retail traders can easily use a variety of tools while trading to manage portfolios, generate higher returns, and create wealth. Hence, retail participation establishes a democratising financial system for all professional and non-professional traders.

• Price Discovery: Retail traders provide a number of additional bids and offers in the F&O market that directly add depth to the market. This makes price discovery more efficient and improves the overall marketing function.

Negative Impact of Retail Participation in the F&O Market

• Higher Market Volatility: Retail traders may make emotion-driven trades or succumb to herd mentality, causing the market to reflect more rapid and unpredictable price movements.

• Speculative Behaviour: Novice traders in the stock market have speculative behaviour driven by hype and short-term trends. This can directly inflate asset pricing and enhance market risks.

• Systemic Risk: Retail traders generally make the trade following the market trend, and if the market moves against their positions, it triggers a domino effect with panic and leads to the closing of unfavourable F&O contracts before expiry.

Retail Participation in the F&O Market: Positive or Negative?

Overall, retail participation favours futures and option trading, , as it significantly increases market liquidity. It also increases the efficiency of the market.

However, retail participation also has certain drawbacks that cannot be neglected.

The participation of retail traders increases the volatility of the F&O market because many individual traders make trades following short-term trends and sentiments. To mitigate this, there are multiple avenues:

• Risk Management: Online trading platforms like Dhan offer a range of tools such as trailing stop loss, trader’s controls, and more.

• Regulatory Oversight: Regulatory authorities can employ various additional mechanisms while ensuring fair market practices.

While F&O participation is already on the rise, these simple steps can help traders make informed trading decisions and mitigate the risks. This can affect the overall efficiency of the derivatives market.

Conclusion

There is no doubt that retail trading in the derivatives segment has increased and is only going to multiply in the coming years. This has definitive impacts on the F&O market, tilting more towards the positive than the negative.

By spreading awareness of this trading instrument, taking precautions by using risk management tools, and maintaining stringent compliance, the overall market efficiency can be maintained and risks can be mitigated.

This article has been produced on behalf of Dhan by ABP Digital Brand Studio.