Derivatives Market in India

Context: The Securities and Exchange Board of India (SEBI) recently banned U.S.-based investment firm Jane Street from Indian securities markets for manipulating stock index and unlawfully earning ₹4,843 crore. This has revived concerns about India’s derivatives market.

UPSC Relevance:

UPSC has asked questions on key economic terms and concepts

Prelims 2024

With reference to the Indian economy, “Collateral Borrowing and Lending Obligations” are the instruments of

a) Bond market

b) Forex market

c) Money market

d) Stock market

Prelims 2023

Consider the following markets:

1. Government Bond Market

2. Call Money Market

3. Treasury Bill Market

4. Stock Market

How many of the above are included in capital markets?

a) Only one                      

b) Only two

c) Only three                     

d) All four

What are derivatives?

• A derivative is a financial instrument whose value is ‘derived’ from another underlying security or a basket of securities.
• It is a contract between two parties. The value of this contract is derived from the value of some assets. This other asset is referred to as the underlying. Derivatives could be based on any of the following assets:
  • Commodities
    • Agricultural commodities like wheat, coffee, pulses, sugar, cotton, etc.
    • Metals like gold, silver, copper, etc.
  • Energy resources like crude oil, coal, natural gas, etc.

• Financial assets like stocks and bonds.
• Intangibles and Market Indices
  • Interest rates
  • Foreign exchange rates
  • Price volatility
  • Credit risk

• Each derivative contract has a date on which it expires known as the expiration date. These contracts are to be settled (in most cases) at a future date at a per-determined price. 
• The difference between the current price and the future price is the compensation payable by one party to the other.
• SEBI regulates derivatives trading through the Securities Contracts (Regulation) Act, 1956 (SCRA), and the SEBI (Derivatives) Regulations, 2000.

Uses of derivatives

• They are believed to have originated for the purposes of hedging the risk of future uncertainties.
• For example, when a farmer sows a crop, he is not sure how much the crop will fetch in the future or even whether it will fail for some reason. In such a case, the farmer may enter into a contract with a merchant, in which case both parties agree to settle the contract at a particular future date at a particular price. Thus, if the farmer is able to deliver the crop, he is assured of the price. The risk of price uncertainty is hedged.
• However, these days, derivatives are extensively used for two other purposes.
  • Speculation – When one wants to make a speculation on the direction of the price of some underlying asset, one can simply buy a derivative rather than buying the underlying asset,  as lower amounts are involved.
  • Arbitrage – There is often a difference between the prices of (i) the underlying in the regular market (called the cash market) and (ii) the price of the futures contract on the same underlying. In such a case, buying in one market and selling simultaneously in another can yield some profits, though mostly small ones.

Various types of derivatives

Risks

High Leverage

• The amount paid for a derivative is small relative to the underlying’s price. This can multiply both profits and losses.
• Incorrect speculation can lead to the loss of an investor’s entire net worth.
• Warren Buffett has reportedly called them “financial weapons of mass destruction.”

Zero-Sum Game

• Unlike other investments (stocks, debentures), derivatives are a zero-sum game. One party’s profit is the other party’s loss.
• Less knowledgeable investors face a high risk of being on the losing side.

Counterparty Risk

• There is a risk that the other party in the contract will not fulfill their commitment. 
• In India, this risk is eliminated for exchange-traded contracts due to the presence of a clearing house.

Recent Trends and Concerns in Investment

• The number of registered Indian investors increased significantly from 38.5 lakh in 2019-2020 to 2.09 crore in 2024-2025. This represents a five-fold increase, often attributed to “financial inclusion” and “economic democratisation.”
• India has the world’s largest derivatives market.
• A SEBI report from September 2024 revealed that the total losses in the derivatives market from 2022 to 2024 amounted to ₹1.8 lakh crore. Despite these losses, more than 75% of those who lost money continued trading in futures and options (F&Os).

Allegations Against Jane Street

• In July 2025, the Securities and Exchange Board of India (SEBI) alleged that the U.S.-based firm Jane Street manipulated the derivatives market.
• SEBI halted the firm’s operations and demanded they pay ₹4,843.7 crore, which was the alleged profit from the manipulation.
• SEBI claims Jane Street used a “pump and dump” strategy: They would buy Bank Nifty stocks in the morning to artificially inflate the price, prompting other traders to buy as well. Simultaneously, they would secretly buy “put options” (which profit when prices fall). Towards the end of the day, Jane Street would “dump” their stocks, causing the price to fall and profiting from their put options.

SEBI’s Regulatory Actions

• In April 2024, SEBI asked the National Stock Exchange to monitor Jane Street’s trading strategies.
• Following the incident, SEBI announced several policy steps to address issues in the derivatives market, including overtrading in index options on expiry days.
• SEBI has also taken measures to curb speculation, such as ending weekly expiries for most derivative contracts. This requires traders to hold contracts for longer periods.
• A SEBI study found that 91% of individual traders continued to lose money even after these reforms, a minor improvement from the 93% who lost money before the Jane Street incident.