The 105-page interim order in the matter of index manipulation of Jane Street Group, a global proprietary trading firm, rocked the stock market last week. The Securities and Exchange Board of India, the stock market regulator, barred a group of four entities from trading in Indian markets and ordered the impounding of their profits. Sebi has accused the group of manipulating the prices of securities for profit. Derivatives, such as futures and options, derive their value from underlying securities, like stock indices or individual shares. Traders around the world buy in markets where prices are low and sell when prices are high. They do that within the cash or derivative market or across markets.
The purpose of trading in derivatives is to make short-term profits. With the help of technology, high-frequency traders can buy in one market and sell in another in microseconds. Now, you can do that between two different counter parties. The accusation in the case of Jane’s Group concerns the use of the same entities belonging to the group, but registered in different geographic locations, for carrying out high-frequency trades. At the same time, shares in the cash market, such as those held by large banks with a high weight in the Bank Nifty, were bought and sold closer to the market close on multiple days. The allegation is that it was done to move the final settlement price in favour of Jane Group companies.
While the reaction in the cash market was subdued, it was evident in a sharp decline in trading volume in the index and stock options segments on the National Stock Exchange last Friday. Those who are into day trading are likely to exercise caution. There are multiple opinions already on the issue. Some reports suggest that the Jane Group is not the only foreign trading firm in the Indian equity options market that comprises index-based options (such as Nifty and Bank Nifty) or stock options. There are other firms as well, and they may be hesitant to enter the Indian market. Brokers offering their opinions are cautious in their response to the Sebi order. Brokers generate a significant remuneration out of the day trading activity through brokerages and fees from you. They are unlikely to be happy about any decline in the trading volume in the Indian stock market.
Some independent experts said on social media that the Jane Group is a resourceful organisation and will pursue appeals against the Sebi order. The outcome of the case will determine the future role of foreign portfolio investors in the Indian derivatives segment. The long-term investors among them will not be bothered. However, those who rely on day trading may want to tread with caution.
What it means
If you are an active day trader, you must use this situation to learn. This column has always maintained the importance of knowledge. The Sebi order is excellent reading material for someone trying to generate income from stock market trading. It explains the situation of the case but also touches upon the basics of options trading. You can understand the dos and don’ts of stock market trading and the associated risks. You will also learn that as an individual, it will be increasingly challenging to compete with technology.
While machines execute transactions in microseconds, it takes far more time for you to execute trading strategies on your own. The significant individual interest in options trading is encouraged as firms that use technology make money at their expense. Derivative trading in futures and options is not a new concept. It is a formidable tool that allows traders to bet on the future price trend of underlying securities, creating liquidity. At the same time, it also helps you hedge the risk against your long-term equity holding.