Nine out of 10 F&O traders incurred loss in FY22: Should retail investors avoid it?

Updated: 30 Jan 2023, 08:07 PM IST
TL;DR.

F&O are trading instruments under the derivatives segment in which the investor doesn’t necessarily have to buy the underlying asset but can gain from its price fluctuations in the market.

Speculating and hedging investments are the key purposes of derivatives trading.

Market regulator Securities and Exchange Board of India (SEBI) highlighted an interesting fact in its report on January 25.

Analysing the profit and loss of individual traders dealing in the equity F&O segment, SEBI said that 89 percent of the individual traders, which means 9 out of 10 traders, in the equity F&O segment, incurred losses during FY22, with an average loss of 1.1 lakh.

On the other hand, 90 percent of the active traders incurred average losses of 1.25 lakh during the same period, SEBI noted.

In FY22, 11 percent of individual traders in the equity F&O segment made a profit with an average profit of 1.5 lakhs, said SEBI.

The percentage went down marginally to 10 percent for active traders, though their average profit went up to 1.9 lakh during the same period, the market regulator added.

For the study, SEBI considered individual client-wise data of realised net trading profit/loss incurred during FY19 and FY22 of the top 10 brokers in the equity F&O segment of NSE.

As per SEBI, these top 10 brokers accounted for nearly 50 percent and 67 percent of the individual client level turnover in NSE equity F&O segment during FY19 and FY22, respectively.

What is F&O?

Futures and Options (F&O) are trading instruments under the derivatives segment in which the investor doesn’t necessarily have to buy the underlying asset but can gain from its price fluctuations in the market.

Before we dig deeper, let's first understand what a derivative is.

All about derivatives

A derivative is a contract that derives its value from an underlying financial asset such as stocks, indices, commodities, metals, currency, bonds, etc. The value of derivatives of an asset class changes according to market conditions.

Speculating and hedging investments are the key purposes of derivatives trading.

There are two major ways of derivatives trading: over-the-counter (OTC) and exchange-traded derivatives.

OTC derivatives are contracts traded between private parties. The OTC derivatives market is unregulated and products such as Swaps, Forward, etc. are traded in the OTC derivatives.

On the other hand, exchange-traded derivatives contracts are traded in standardised forms. Here, the exchange acts as the intermediary.

The four most common examples of derivative instruments are - Forward Contracts, Futures Contracts, Options Contracts, and Swap Contracts.

Let's understand the one by one.

Forward contracts are customised contracts between two parties to buy or sell an asset or any product or commodity at a predetermined price at a future date. As per brokerage firm Angel One, Forward contracts are not traded on any central exchanges, but over-the-counter and they are not standardised to be regulated.

Futures are exchange-traded contracts to sell or buy financial instruments or physical commodities for future delivery at an agreed price. Futures are fundamentally similar to Forwards but the key difference is that Future contracts are traded on exchanges so they are standardised and regulated.

Options are financial contracts wherein a trader has the right to buy or sell a security or a financial asset at a predetermined rate in the future but he or she is not bound to do so. In simple terms, the parties involved in options contracts are under no legal obligation to keep their part of the deal.

Swaps are nothing but exchanging one kind of cash flow with another. As per brokerage firm Angel One, Swaps are not traded in exchanges but are private agreements between parties and are mostly traded OTC. The most common types of swaps are currency swaps and interest rate swaps.

Should retail investors avoid F&O trading?

F&O trading is risky because it involves a lot of guesswork. The price of a stock cannot be predicted precisely even for the near future.

For example, suppose the market mood is bullish and one stock is trading at 100. Investors may assume that the fundamental and technical factors of the stock are sound so it should reach the level of 120 in the next 10 days.

But due to a sudden knee-jerk reaction to any event or development, the stock price falls to 90 or jumps to 150. If you are in the futures contract for that stock, you will suffer losses or gain huge profits.

So, the question is not whether you should avoid F&O or not. The real question is - does it suit your risk appetite, and do you completely know the nuances of F&O trading?

"Trading in the F&O segment is a very subjective topic, as one needs to be proactive in the markets and requires a particular skill set to gauge momentum and minimize risk exposure," said Osho Krishan, Senior Analyst - Technical & Derivative Research, Angel One.

"The world of derivatives trading can be lucrative to those with a risk appetite and a keen understanding of the subject matter. One also needs to understand the features of F&O trading before entering trades, as it is directly related to price discovery. Simultaneously, retailers should restrain themselves from extra leveraging positions and maintain strict stop losses to mitigate capital erosion. At the same time, a timely exit is also the key to getting profits and avoiding being too greedy to generate a fortune from one trade," said Krishan.

Disclaimer: The views and recommendations given in this article are those of individual analysts and broking firms. These do not represent the views of MintGenie.

What are futures and options?
First Published: 30 Jan 2023, 08:07 PM IST