Implications of new SEBI rule abolishing DNE: The Hindalco case in point

With the increasing number of retail investors and traders flocking the Indian stock market, one would assume that SEBI would have preferred protecting the smaller investors.

Lakhs of retail traders are putting their hard-earned money in the market by banking on the sanctity of the Indian stock exchanges and the regulator. However, the horror story of a Hindalco put option trade that costed lakhs to small retail traders (Read here: New SEBI options rules misfire, share traders bear brunt with lakhs in dues) indicates anti-small-trader actions that are set to hurt the retail populace seeking to earn a living out of the stock market. The action exposes the vulnerabilities of the common man with poorly conceptualised actions of exchanges and regulators.

With the removal of the DNE facility, the small retail trader who used to take limited risk of losing his premium money by buying puts, is now exposed to the unlimited risk of having to buy shares through auction, in case he is unable to square off his positions before expiry.

That is exactly what happened in the Hindalco December expiry, where 450 strike price put buyers could not square off their positions as put sellers (writers) vanished in the last one hour of trade, on the expiry day, i.e. December 30. In absence of buyers, put holders could not square off their positions and were forced to buy shares in auction so that they could provide these shares to put writers at ₹450. That is, they were forced to buy the Hindalco Shares from the open market at a price much higher than ₹450 and sell them at ₹450. EUREKA!

“SEBI, NSE and BSE must explain for whose benefit they are implementing such rules,” asked Anand, an aggrieved trader who lost a big fortune in this trade.

The put holders, who paid a premium of ₹2 per share for a lot size of 1,075 shares of Hindalco, shelled out ₹2,150 per Lot. Since put writers mysteriously vanished on the expiry day, the put holders could not sell their put hold, and thus were unable to square off their positions. They were thus forced to buy the actual shares from the auction market. Which means that if a put holder ‘Held’ one lot of Hindalco, they needed to buy 1,075 shares at price that they got on auction day, which was ₹480 per share. So, a put holder bought one lot of Hindalco by shelling out ₹5,16,000 (1,075 multiplied by ₹480) and then they sold these shares to put writers at ₹4,83,750 (1,075 multiplied by ₹450) suffering a loss of ₹32,250 per lot. On top of that, these retail traders also paid penalty and interest expenses that burned a hole in their pockets.

If the DNE facility was available to these retail traders, the loss would have been limited to ₹2150 per lot, instead of ₹32,250 per lot.

Most retail traders Fortune India contacted were unaware of the abolition of DNE facility. None of the traders were informed by their brokers about the change in the rules. All of them entered that particular trade by assuming that their losses would be limited to the premium they paid to buy the put option.

Since these retail traders are mostly middle-class individuals, they had limited their risks to small amounts that they could afford to lose. However, their losses turned out to be more than 1,500% of their assumed maximum loss. In many cases, where small traders held high lots of put options, they defaulted.

In case retail traders default in droves, their brokers would bear the brunt of these losses. So, if things continue as they are, such defaults may create systemic risks in future. This rule also jeopardises brokers who have a high number of retail traders like Zerodha, Upstox, Groww, and 5Paisa.

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SEBI, NSE, BSE silent on systemic exploitation by options writers in Hindalco trade