Short dated options are useful
by Urvish Bidkar and Ajay Shah.
Business Standard, 15 September 2025
A debate is underway in India on whether the state should use its coercive power to prohibit weekly option contracts. This follows regulatory concerns about the scale of retail participation and the high proportion of individual traders who incur losses. While these concerns are understandable, a ban would be a policy error. It is a misdiagnosis of the problem and risks damaging hard-won financial-market development. We should not dismantle functioning markets; we should learn from global experience and foster a deeper, more resilient financial ecosystem.
The debate is being framed incorrectly as a tradeoff between speculation and investor protection. The correct framing, grounded in financial economics, is about whether India should continue on the path toward creating more liquid and more complete markets. Financial derivatives are not only instruments of speculation; they are fundamental tools for customising risk. The Nobel-winning work of Kenneth Arrow and Gerard Debreu provides the theoretical ideal: A `complete market' where a security exists for every possible future `state of the world', allowing any risk to be perfectly hedged. While a truly complete market is unattainable, financial innovation strives to approximate it. Short-dated options are the closest practical instruments we have to one-period Arrow securities, allowing participants to isolate and trade the risk of a single event on a single day. They perform an economic function -- enhancing the liquidity and efficiency of the overall securities markets. Banning these instruments would make our markets less complete, less efficient, and less liquid.
The Indian equity derivatives ecosystem has made progress, but excessive attention has shifted to protecting some individuals from facing losses. While the data on retail losses is a concern, the proposed solution is flawed. The problem is not the instrument itself. The recent scrutiny intensified after the Jane Street case, an episode the chairman of SEBI correctly identified as a `surveillance issue', not an indictment of the product. To ban the product is to punish the entire market for a failure of surveillance or individual decision making, a dangerous break from the long-term policy of market development.
A live experiment gives us insight. In May 2022, the CBOE began offering options on the S&P 500 index with daily expiries, known as 0DTE options. By mid-2023, 0DTE trading accounted for over 43 per cent of total S&P 500 options volumes, with a notional daily volume around $1 trillion. This explosive growth shows that these products are valuable, and they are performing a useful function for voluntary users. And this explosive growth, contrary to fears, did not cause systemic instability. It created a deep, liquid, and balanced ecosystem. The CBOE data shows the market is not a one-sided speculative frenzy: Retail clients account for roughly 55 per cent of the flow, but sophisticated institutional clients make up the other 45 per cent.
In the Indian discourse, short-dated options are slammed as being `mere' speculative instruments. Researchers have worked with the CBOE data and found that they are used in sophisticated and sensible ways, from precise event hedging by institutions to tactical intraday strategies. The concern that such products create volatility is also not borne out by evidence; studies show that overall close-to-close realised volatility has not significantly changed. The United States experience is proof-of-concept that a mature financial ecosystem can successfully achieve depth in short-dated options trading -- depth that enables useful applications chosen by a wide variety of market players. What India needs is a wave of high-quality research that understands the nature of what is happening under Indian conditions, so as to protect policy making from impressions, prejudices and political economy.
The rationale for a ban rests on paternalism, contradicting a core principle of economic liberty: Consenting adults should be free to enter into contracts. The state's role is to enforce contracts and prevent fraud, not to prohibit risk-taking. Many vital economic activities, from angel investing to running for the UPSC, have high failure rates, yet the government does not intrude into the individual's right to pursue her objectives. The vast majority of new businesses fail! But the government does not require an examination before a person starts a business.
Policy debates in India often create a false dichotomy between `good' hedging and `bad' speculation. Speculators are the lifeblood of liquidity; a hedger needs a speculator on the other side of the trade. Banning a product to curb speculation inevitably punishes legitimate hedgers by draining liquidity. When trading in derivatives is banned, the underlying risk does not vanish. To some extent, activity does subside, which harms liquidity. To some extent, the demand for risk transfer will be driven into less transparent channels like offshore or illegal markets, placing participants outside Indian law and blinding regulators to the true buildup of risk. The intervention, intended to reduce risk, would perversely increase it.
The purpose of the securities markets is to achieve liquid and efficient markets. Achieving this financial development is a critical input to Indian economic growth and should be the focus of policy. Instead of prohibition, a superior path exists. The key is not fewer retail participants but more institutional ones. Policy should focus on enabling domestic institutions to do more with derivatives by removing the state impediments that hold this back. The regulator should enhance transparency through clearer risk disclosures and initiatives on financial literacy initiatives. If expiry-day volatility is a specific concern, the focus should be on technical market-design solutions like call auctions for the closing price.
The materiality of the Indian equity market lies not just in the domination of equity financing in shaping private-investment activities but also as the institutional foundation for future progress on commodities, currencies, and government bonds. That upside potential requires success on the equity market.
Short-dated options are a healthy and successful aspect of the derivatives markets. Policymakers should see this not as a threat but as an opportunity to build a more sophisticated and resilient financial system.
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