The pitfalls of just looking at trading turnover figures to determine market activity

27 Feb 2023

News headlines scream about options volumes overtaking cash volumes. But just looking at volumes & not unique users can be misleading.

Jump in options last 2 yrs is mostly due to intraday stock traders switching to options after intraday leverage restrictions in early 2021

~10% of active traders contribute ~90% of trading volumes, in mostly intraday cash and F&O.

Comparing trading volumes of traders to equity investors is like comparing apples to oranges or brinjals.

Until 2021, brokers could offer as much intraday leverage as they wanted. This made trading stocks attractive.

But once maximum leverage was capped at 5X, intraday traders switched to F&O, given the ability to hold shorts and leveraged positions overnight.

F&O volumes grew faster than cash volumes because the most active traders switched to F&O. But if you look at unique traders, equity as a percentage continues to be much more than F&O. Yes, F&O participation has increased, but equity has increased much more.

I think there is another regulatory reason behind the rise in retail contribution from 27% to 36%. In March 2020, due to COVID-induced volatility, the notional F&O exposure value at a client level was capped at Rs 500 crores to reduce risk.

This capped the position limit for institutions in derivatives at Rs 500 crores or ~6000 lots Nifty, which restricted the trading volumes of others except retail. This, I think, is why retail % contribution in derivatives has picked up in the last 3 years.

In this post, I explain why you shouldn’t compare only trading volumes and conclude that speculative activity is unusually high just because option trading volumes are at all-time highs. It is important to track participation by unique users as well.

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