The Bumpy Road of Derivatives: Uncovering the Potholes in India’s Capital Markets
The recent Sebi order on Jane Street has sent shockwaves through India’s capital markets, exposing risks that have been simmering for years. The saga has raised critical questions about India’s regulatory framework for the securities market, particularly the handling of equity derivatives since their formal launch in 2001.
In this article, we will delve into the history of derivatives in India, examine the market structure that allowed high-frequency traders to potentially profit from the derivative misadventures of retail investors, and discuss the regulatory lapses that enabled such firms to operate with relative impunity.
A Brief History of Derivatives in India
India’s derivatives market was introduced in 2001, with the formal launch of futures and options contracts. However, the introduction of individual equity futures alongside index products was seen as a concession to the influential community of stockbrokers, who were in search of a speculative—and liquid—product to replace the banned badla.
Sebi’s initial excuse for not introducing physical settlements was that exchanges lacked the required technology, infrastructure, or management capacity to cope with the burden of physical settlements. Consequently, the futures and options market became a casino with no cover charge, or minimum buy-in requirements, fuelling large and unnatural spikes.
The Rise of High-Frequency Trading
High-frequency trading firms like Jane Street have been a major force in India’s derivatives market. These firms use sophisticated algorithms and co-located servers to execute trades in fractions of a second, often at the expense of retail investors.
Sebi’s tracking data shows that a bulk of the derivatives trade orders originate from co-located servers, or from institutional traders that pay a higher fee to locate their servers next to the exchange servers, thus allowing them to strike deals within nano-seconds.
The Regulatory Framework
Sebi’s regulatory framework has been criticized for being too lax, allowing high-frequency traders to operate with relative impunity. The regulator’s decision to introduce individual equity futures alongside index products has been seen as a concession to the stockbroking lobby, rather than a move to create a more transparent and investor-friendly market.
Furthermore, Sebi’s failure to introduce physical settlements in a timely manner has allowed high-frequency traders to manipulate the market, often at the expense of retail investors.
The Impact on Retail Investors
Retail investors have borne the brunt of the derivatives market’s volatility. Sebi’s data shows that 91% of individual traders incurred net losses in equity derivatives during 2024-25, with total losses crossing ₹1 trillion.
The surge of uninformed retail investors entering the derivatives market, lured by the facility of low capital commitment and easy profits, has further exacerbated the problem. Sebi whole-time member Ananth Narayan has stated that 61.6% of derivatives trade orders originate from co-located servers, primarily used by proprietary traders.
The Way Forward
Sebi must take a closer look at the regulatory framework and market structure that has allowed high-frequency traders to potentially profit from the derivative misadventures of retail investors. The regulator must also identify fintech companies that have inveigled unschooled retail investors into derivatives trading, thereby providing large traders with easy pickings.
Finally, Sebi must coordinate regulatory action with the Reserve Bank of India (RBI) to overhaul the profile of India’s derivatives market in favour of large institutional traders, especially by reworking the outdated rule that limits bank finance for institutions.
