By CKG Nair & V Shunmugam, respectively, Former Director, National Institute of Securities Markets, and Partner, MCQube
Various regulatory measures taken up in the past six months—including regulatory tightening, enhanced surveillance, and punitive actions against high-frequency trading entities like Jane Street—have effectively cooled India’s equity derivatives frenzy. Volumes that once seemed unstoppable have decreased. However, this slowdown might be temporary unless more fundamental structural changes occur. The regulatory measures attempted to address the excesses in derivatives, but the real challenge is maintaining this effort until the market’s underlying framework is reshaped. A half-finished battle could leave the system vulnerable to the same excesses that were briefly subdued.
The surge in derivatives, especially weekly index options, has been both remarkable and concerning. Notional turnover increased at a rate unmatched in any major economy, often surpassing the cash market by more than 20 times. This explosive growth wasn’t driven by fundamental investing or long-term hedging, but by a behavioural shift towards leveraged, short-term trading. Algorithmic strategies and complex, machine-driven orders began to dominate daily turnover, while retail investors—often unprepared and inexperienced—rushed into seemingly straightforward opportunities. The marketplace turned into a high-speed race where Ferraris and scooters shared the same lane.
The Security and Exchange Board of India’s recent discussion paper on delta-based filters aims to reverse that trend. It would help ensure liquidity concentrates on meaningful strikes, reduce noise trading, diminish excessive volatility, and align market behaviour more closely with risk management goals. Alongside tightening of margin requirements, eligibility standards, and transaction costs, these proposals continue careful regulatory efforts to restore balance without overly restricting market innovation. These steps are commendable, but they form only a part of the solution. The deeper question is what should follow. The derivatives market, even in its cooled form, remains disproportionately large relative to the rest of India’s financial architecture. It is time to look beyond the immediate regulatory perimeter and envision a new balance—one that preserves liquidity, fosters innovation, and reorients household savings towards productive investment.
Three complementary actions could reinforce regulatory reform efforts.
First, exposure must be aligned with financial capacity. Retail participation in derivatives has grown exponentially, but the imbalance between risk capacity and exposure remains unaddressed. Linking derivative exposure limits to verified income or net worth can align risk-taking with financial resilience. This principle—practised in several mature markets—ensures that the scale of participation matches one’s ability to absorb losses.
Second, dynamic risk controls must be introduced. On volatile days, reassessing intraday positions and recalibrating margins can help prevent cascading losses. Expiry-day activity, when retail enthusiasm peaks and option premiums plummet, should be governed by stricter risk parameters. This approach not only reduces leverage but also enables market platforms to charge margins that reflect the risks that retail investors face.
Third, market incentives should be redirected. Behaviour responds to incentives. A modest difference in the securities transaction tax, favouring delivery-based equity investments over ultra-short-term derivative trades, could shift retail focus towards ownership rather than speculation. Similarly, investor interfaces can include periodic reminders of historical loss ratios in derivatives—not to deter, but to raise awareness about the low probability of winning. Behavioural nudges often achieve what rules alone cannot.
Each of these measures complements the ongoing reforms. Together, they guide the market towards a structure where speed, sophistication, and scale coexist with fairness, transparency, and resilience.
Critically, the goal is not to penalise success or limit participation. India’s derivatives market remains one of the most technologically advanced and accessible. Its efficiency symbolises how far India has advanced in democratising finance. But efficiency must serve a purpose. A marketplace where most domestic savings chase intraday volatility cannot be the foundation of a $10-trillion economy. The question, thus, is not whether derivatives are good or bad, but whether they are fulfilling their intended purpose—hedging and pricing risks.
This is also a moment to reassess where the next frontier of financial innovation should emerge. The time has come to broaden focus to markets that remain underdeveloped but are vital to India’s economic trajectory—interest-rate derivatives that stabilise borrowing costs; corporate and municipal bond markets that fund corporates, infrastructure, and cities; and commodity derivatives that connect farmers, miners, and manufacturers to global value chains. These are the pillars of a mature financial system.
Inclusion must be the next wave of reform. The democratisation of access via mobile trading and digital onboarding has been remarkable, but inclusion is not just about entry but also empowerment. Retail investors, small institutions, and emerging entrepreneurs should see markets not only as a place to trade but as a platform to grow their wealth. Investor education, multilingual certification, and tiered participation based on skill can help ensure participants engage with products they understand. Exchanges and intermediaries share this responsibility—to make markets intuitive, informative, and fair.
The link between market health and economic competitiveness cannot be overstated. Financial markets are not just sideshows to economic growth, they are its vital core. When properly nurtured, they direct household savings into enterprise, infrastructure, and innovation. When out of balance, they can divert that energy into unproductive churn. India’s regulators understand this nuance—their challenge is to translate discipline into depth, turning volatility into vitality.
The measures taken so far—and those proposed—are first steps towards a more profound realignment. By shifting focus from speculative derivatives to investment-backed markets, ensuring participation is well-informed and proportionate, and leveraging technology for inclusion, India can reestablish its financial infrastructure for long-term growth.
India’s goal to become a developed economy by 2047 requires capital markets that are extensive, robust, and reliable. The current reform effort is not about slowing down the market but aligning it with national priorities. A financial system that directs its considerable trading energy into innovation, entrepreneurship, and infrastructure will not only reflect but also amplify India’s economic transformation.
Regulation has stabilised the wheel. Now, it must join hands with policy to steer the direction. The derivatives boom has shown India’s market potential—the reforms ahead will define its purpose. A market that rewards prudence, encourages ownership, and channels savings into wealth creation will not just accompany India’s “Viksit Bharat” journey—it will propel it.