VR Logo

Resisting the Lure of Effendo

The Sebi is planning to increase the contract size of derivatives. Regardless of whether it does so, serious long-term investors should always avoid these

A few days ago, there was a news report in The Economic Times about the Sebi planning to increase the contract size in futures and options (F&O, or effendo as it's generally called) trading on the stock exchanges. For the last 15 years, the contract size has been ₹2 lakh. Reportedly, the Sebi now wants it increased to ₹10 lakh. The contract size governs the minimum ticket size that a futures or options (F&O) trade has to be. By increasing the contract size, the Sebi would like to ensure that only rich traders trade in the F&O segment.

And why would the Sebi want to do that? The answer to this question lies in one of the many distortions that have crept into the Indian stock market ever since derivatives trading began. Derivatives, like futures and options, can be used to protect traders against risk, acting like an insurance policy. However, they can also be used to enhance risk and returns, effectively as an instrument that offers a chance of higher gains but also a high risk of huge losses, which could completely wipe out the investor's capital. In any case, even by cost inflation alone, the ₹2 lakh limit should have been enhanced long ago. The Sebi has been tardy in doing this and has allowed the real limit to effectively come down.

The problem is not with using futures and options as an instrument of hedging. The real problem is that almost every part of the equities trading industry is dedicated to getting customers into F&O trading. Practically every broker does this and certainly all stock exchanges have spared no effort in getting as many people to trade as speculatively as possible. This kind of institutional behaviour is certainly disappointing.

The Sebi's reported move is based on the idea that traders who have more money can afford to take risks with highly speculative instruments, while others should not. Of course, brokers and stock exchanges are strongly opposed to what the Sebi has proposed because it means lower revenues and profits for them, although their official reasons talk about market liquidity, et cetera.

Readers must be familiar with futures and options. Since practically all of you deal with some brokerage or the other, you would definitely have had salespeople pitching these products to you. They would certainly have told you that all smart investors trade in futures and options and that those who don't do effendo are fools who are throwing away opportunities of making quick money.

No doubt, many of us would succumb to such talk and doing exciting things. Others may not have tasted the excitement of effendo but may have been tempted. For all such investors, Wealth Insight has a simple piece of advice: There's great value in boredom. If you are a long-term, fundamentally driven value investor, then you do not need derivatives even for the valid reason of risk reduction. These are inherently traders' devices. For long-term investors, conventional, boring approach of value investing and cost averaging are enough to manage risk.

As I said above, it takes a bit of effort to avoid the effendo pitch because your brokerage must be pitching it to you aggressively. Remember, low-key investing means very little profit for your broker. No doubt, your account manager would be under pressure to make you do something that would transfer more of your wealth from your pocket to your broker's.

However, this is something that we must resist. Even if the Sebi manages to resist pressure from the exchanges and increases the limit and even if you have enough money to trade in effendo, a serious and thoughtful investor must resist the temptation.