By imposing a temporary trading ban on Jane Street Group, one of the biggest names in algorithmic trading, and freezing 48.4 billion rupees ($570 million) of its past profits, the market regulator in Mumbai has sent shock waves through the corridors of global finance. The Securities and Exchange Board of India’s interim order, which has been disputed by Jane Street, accuses the firm of running “an intentional, well-planned and sinister scheme” of market manipulation.
The New York-based quantitative trader, whose spectacular success in Indian equity derivatives garnered $2.3 billion in net revenue last year, according to a Bloomberg News report in May, said it will further engage with the SEBI. Jane Street “is committed to operating in compliance with all regulations in the regions we operate around the world,’’ it said. The company has 21 days to file its response.
Also read: Jane Street to contest SEBI’s manipulation charges
The probe isn’t over yet. The 105-page order has focused on 18 days when options on Bank Nifty, a popular index of India’s largest lenders, expired with high profits for some traders. Jane Street, the SEBI says, manipulated intraday prices on 15 of those 18 occasions. On the remaining days, the regulator alleges that the group came in with “aggressive and large” orders toward the end of trading to force the index to close in its favour. The SEBI will now probe the quant giant’s strategies for other indexes.
The gamification of finance that began during the pandemic never quite went away. That’s true almost everywhere. But more developed markets allowed people to scratch their speculative itch in the stock market — or on novel instruments like cryptocurrencies. In India, where digital assets are heavily taxed, the cash-equity market is relatively shallow, and capital controls force most household wealth to stay at home, equity derivatives became the focus of a full-blown mania.Toward the end of 2023, the turnover from futures and options on indexes and stocks was more than 400 times the value of shares changing hands on the National Stock Exchange in Mumbai. No other market in the world was as lopsided, as I wrote back then.But this is what you get when risk-taking is concentrated in small sachets. The SEBI order illustrates that with an example. A day before contract expiry, the option-market equivalent of being long one underlying share worth 100 rupees may require an outlay of just 1 rupee (1.16 cents), unless the stock is expected to be highly volatile in that period for some reason.
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To command the same economic interest for 24 hours as an ordinary stock by paying 1/100th of its price is leverage, a feature not a bug. But the never-ending carnival of options expiring through the week, as had started to happen before the regulator came cracking its whip, was avoidable. As were small contract sizes that lured young men with dreams of quick riches. (Most individuals dabbling in derivatives are men, from the 20-to-30-year-old age group.)
Belatedly, some of those infirmities have been addressed, and the ardour has cooled. The Jane Street order will do the rest. Once the shock has been absorbed, the regulator should ban contracts that expire more frequently than once a month. But before the SEBI staff start passing around cigars, they should perhaps recognize what they haven’t done yet: Make cash equity great again.
One way to do that is by broadening participation. Now may be the time to give individual investors overseas the same unfettered access to cash equity as locals, according to Andrew Peretti, a former buy-side trader in Indian markets. A deeper stock-borrowing-and-lending pool, he says, will make it easy to short overpriced shares. Finally, corporate power needs to be reined in. No analyst wants to be thrown into jail for a “sell” recommendation. A robust cash-equity market is the best protection against potential manipulation from higher derivative volumes.
Hopefully, the Sebi order will also end the $500,000 pay packages for local engineering graduates at high-frequency trading shops. India needs more young talent in science and technology, robotics, and artificial intelligence. R.H. Patil, who ushered in a modern equity market in India by setting up the National Stock Exchange in 1994, cautioned about letting speculation dominate everything else. “All those who talk of totally free markets do not recognize that we need broad-based industrialization and infrastructure development to tackle poverty,” he wrote in 2010.
Back then, Patil was upset with the regulator for fueling a runaway craze for single-stock futures. The post-pandemic frenzy has been a lot worse. The Sebi’s own research pegs three-year losses for retail players at $21 billion. Nine out of 10 derivative traders have lost money. At the very least, the Jane Street investigation should help them understand why they had no chance of winning against the whales.
Next time the punters feel tempted by a 1 rupee option on a 100-rupee share, they should instead buy 5.5 millilitres of Unilever Plc’s Sunsilk. Options can sting a lot more than a bit of shampoo in the eye.
