The options market in India is exploding
As an erudite and lettered customer of Callanish Capital perhaps you can agree with Greek philosopher Sophocles, who said that “wisdom outweighs any wealth”. You might perhaps go one better than Sophocles and add that it takes some wisdom to protect your hard-earned savings in this world of high inflation and uncertainty.
We at Callanish Capital also work hard to protect savings from inflation, investment fads, and financial bubbles. The difficulty with spotting financial bubbles is that calling them prematurely can make you look like Chicken Little, who you may remember continually predicted that the sky would fall down.
However, for our money, there is a bubble emerging in the options market, and it is being inflated by smaller investors. Options have utility in certain circumstances, for example to farmers and industrialists, but buying options is a long-term losing strategy akin to taking a trip down to the bookies every day. You are pretty much guaranteed to lose money in the long run.
Thankfully, regulation in Europe makes it very difficult for small investors to punt around in options, yet it may surprise you to learn that the explosion in options trading is happening in India, where it has been more than doubling every year since 2019. The volume of trading there easily eclipses that in the US or China. It is estimated that more than one in ten adults are now trading Indian stock options. The chart below shows the explosion in option volumes in India. Quarterly volumes were virtually zero in 2017, but surged to 30 billion per quarter by the end of 2023, and they have reportedly grown by over 100% in 2024.
Source: FIA
This has proved to be a bonanza for the brokers, banks, and hedge funds that service this explosion of demand. For those of us lucky enough to work in finance, we joke that options traders are expert in Greek because of the obscure mathematical notation they use to manage their profitability. To give a flavour of this, without wanting to get too technical, there is theta, which is the amount of time left on an option before it expires, there is vega which is related to the volatility of the underlying share price, and there is rho which is the option’s sensitivity to interest rates. In addition to these there are delta, gamma, vanna and, our favourite, vomma. These can be complex products, and in our view are wholly unsuitable for retail and unsophisticated investors.
Yet small investors trading options has also exploded in the US and some other countries, though India is the standout. One side effect of the burst in trading activity has been a 25% annual increase in unsecured consumer debt in India, which some commentators say is due to small investors borrowing on their credit cards to put cash into the market.
The Indian government is aware of what is going on and is concerned that a market setback could leave small investors nursing large losses and lots of debt. A market fall could therefore damage the Indian banking sector; if the banks have to write off this unsecured debt, this could ultimately have a real-world impact on the Indian economy.
As a result, the Indian government is gradually taking steps to make it more difficult for small investors to buy options. The steps, though, are incremental because if the government banned all small investors from the options market that too could lead to a substantial fall in the stock market, lots of debt, damage to the banking sector, and real-world consequences.
While Callanish Capital watches the Indian situation from behind the sofa, our portfolio managers have largely avoided the Indian market which, in the short-term, might be a painful step, but could pay off in the long run. India has a big economy and a large stock market but we estimate our exposure to India for our Balanced investors is less than 1% in total. If things do go badly in India, we are optimistic our investors will be sufficiently diversified not to notice.
It is very sad to see so many investors putting their money into options, wherever they are based, when we know that buying options is a losing game over the long term. We are perhaps all guilty of being over-optimistic and over-estimating our abilities, whether it be trading options or our ability to drive safely. Hopefully, though, we have enough wisdom to be aware of this. As the Greek philosopher Plato once said, “the worst kind of deception is self-deception.”
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Callanish Capital Ltd is a Discretionary Fund Manager, directly authorised and regulated by the Financial Conduct Authority (“FCA”) under registration number 955992.