Embedded Leverage fuelling Option Trading

Indian traders prefer index options due to large embedded leverage. The effective leverage on an index option during expiry day is 500 times, which means an option premium payment of approx ₹2,000 allows exposure to the Index worth approx ₹10 Lakh. Such option bets are largely speculative in nature and traders’ holding time for such options is on average for just 30 minutes, points out Axis Mutual Fund report.

Currently, in most stock markets, derivatives volumes account for 5 times to 15 times of their cash market volumes. But in India, derivative volumes are more than 400 times higher than that of the underlying cash market. It has grown from 3 times in 2010 to 400 times in 2023.

Sachet-ized Trading, a new norm

The introduction of shorter duration in options has effectively “sachet-ized” trading, reducing the capital needed to take on similar risks. Weekly options are cheaper compared to monthly contracts, and buyers gain exposure to the full notional value by paying only 0.5% to 5% of the underlying asset.

For example, Nifty's at-the- money (ATM) weekly contract is available at 40% of the cost of a monthly contract while offering the same notional value. This effectively increases leverage to 126 times, from the 56 times leverage offered by monthly contracts. In the case of zero-day-to-expiry options, leverage increases further to an astonishing 420 times, states the report.

Push to even shorter durations has ensured that the options market is shifting from hedging to speculation. Weekly options today account for 95% of volumes in the index. Exchanges this year have re-aligned the expiries and these are available for every day of the week.

Most of the option volumes are speculative and this can also be gauged from the fact that open interest at the end of the day is only 1% of the daily traded volumes, i.e. only 1 out of 100 contracts are carried forward to the next day.

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weekly expiries

Alert! Derivatives now 99.6% of market volumes; weekly expiries spawn 'Options Warriors'