Indian regulators’ attempts to protect retail traders are backfiring

JOINING THE Indian upper middle class often requires winning a lottery. Hundreds of thousands apply for the H1-B sweepstakes, hoping to land a skilled-worker visa to America. Millions sit exams for one of a few thousand coveted government jobs. And millions more are trying their luck in the derivatives market.

Options, which confer the right to buy or sell an asset at a given price in the future, are particularly popular. Because investors can gain large notional exposure for a small premium, the fortunate can turn a 2% move in a benchmark index into “multibagger” that returns many times the original investment. Most punters, though, are not fortunate. A study by the Securities and Exchange Board of India (SEBI) found that nine in ten traders lose around $1,400 a year, a vast sum by Indian standards.

SEBI has tried to discourage novices by raising the minimum contract size, stopping brokers from offering credit and other restrictions. It has also targeted market-makers it sees as taking advantage of unsophisticated patsies. It has pursued a case against Jane Street, an American hedge fund, which it accuses of market manipulation. On August 20th it banned a Mauritius-based vehicle owned by JPMorgan Chase, an American bank, for similar offences. All this has taken some of the steam out of the options boom. In the past year or so volumes of index options, the most popular sort, have fallen by 52% and the number of registered derivatives traders is down from nearly 10m to 7.9m.

The crackdown might, though, have gone too far. On August 3rd the National Stock Exchange and the Bombay Stock Exchange (BSE) introduced at the end of the session a 20-minute “closing auction” for the 200 or so stocks on which options (and futures) are written. The closing price for a stock is one that matches all orders in the auction so as to maximise the volume of trades. It replaced the old system, in which closing prices reflected a stock’s volume-weighted average price in the last half-hour of continuous trading.

The rationale behind the change was in part to prevent big traders “marking the close”. This is when someone places timed trades just before the market shuts, when most traders are gone for the day and liquidity is low, to move the closing price and pocket a derivatives win. It is this sort of manipulation which SEBI alleged against Jane Street. (Jane Street insists what it did was ordinary market-making.)

Whether or not the auctions keep manipulators away, they are causing havoc for options traders. Because participants see only their own bids and offers, market-makers, who exploit the publicly known spread between the two, tend to sit it out. Without their liquidity, trading is thin and volatile. On August 27th share prices on the BSE’s Sensex index collapsed by 3% in moments during the closing auction. For owners of related options, such swings can mean a blow-out or a blow-up.

Another effect is to push the very Indians SEBI aims to protect to seek multibaggers elsewhere. Total margin loans that brokers extend to traders who want to amplify gains (but risk compounding losses) grew by 50% between mid-2025 and mid-2026, to $15bn. Nithin Kamath, co-founder of Zerodha, a popular brokerage app which offers margin trading, has called it “scary”. Indian fortune-seekers will not easily be frightened away. ■