I got a lot of love from many of you for last week’s post “The Jobs Money Can’t Do.” I had lined up another one continuing this train of thought. But I came across an interesting and surprising data point this morning. I knew I had to write on this one as I was itching to pen my thoughts.

So, what is that data point?

As per Wall Street Journal, 78% of equity options traded worldwide were traded in India last year. The number of equity index options traded on Indian exchanges reached 84.3 billion contracts in 2023 contributing to the global total of 108.2 billion options traded worldwide. We have beaten everyone…US, North America, China, Europe, and everyone else.

One reader wrote, “This trading drug is more addictive than cocaine, heroin, and all the other shit out there.” There is no shortage of people wanting to use this drug and then losing their hard-earned money. The irony is – many still think they are investing.

What’s really happening here?

Are we creating more addicts?

Dhirendra Kumar, Editor – Value Research, recently wrote, “The stock exchanges have dropped all pretence of not being in the casino business. They have shamelessly launched any number of products- like the ridiculously daily/weekly expiry derivatives- which have no use except gambling. On top of that, the launch of online brokers and trading through apps has meant that people trade all the time as a side activity. The saddest part is that for a large proportion of these market participants think that this is what stock markets are. Fundamentally driven long term investments are simply not on their mental horizon.”

Look at all the IPL and cricketing (including world cup) advertisements over the last 12 months… Most of these advertisements are by stock trading and online gaming companies…The best part is that the online brokers keep confusing people by using the terms investing and trading in the same breadth…

The rise of trading platforms that make entering the F&O market more accessible has been a double-edged sword. On one hand, it democratizes finance, giving people the opportunity to engage with sophisticated financial instruments. On the other, without proper knowledge and risk management, it becomes akin to gambling, with dire consequences.

And there is no democratization of finance in this…It simply is enabling gambling…rather encouraging people to gamble…in its purest form…Democratizing Finance are the two most abused words. Democratization is about giving people access to things they need or even want…but it’s never about showing that there is quick money to be made here …so come here and gamble…

Retail and HNI investors, drawn to the potential of high returns, often overlook the intricate complexities of options trading. Unlike investing in stocks directly, which grants the investor a share in the company, options trading is essentially betting on the future price movement of an asset. It’s speculative, and while it can lead to substantial gains, it also carries the potential for significant, sometimes total, loss of capital (and most of the times people lose all their money).

Moreover, the impact is not limited to financial loss. The stress of volatile markets and the pressure to continually monitor positions can take a toll on one’s mental health and relationships. The addictive nature of trading can disrupt work-life balance and strain familial ties, creating a cycle of stress and loss that extends beyond just monetary aspects. I can’t tell you how destructive this really is.

As an industry, we need to reflect on the message we’re sending to investors. Are we equipping them with the tools and knowledge needed to navigate these complex financial instruments responsibly? Or are we merely pushing them towards a precipice of high-risk trading without a safety net?

In 2024, the founder of one of the largest trading platforms in India, said in a Business Today interview, “Our mission as a business has evolved naturally since starting in 2010, when it was all about reducing costs and bringing transparency to broking. Today it is about helping the customer do better with their money and manage their wealth holistically, not just in terms of money.”

In the same interview, the founder said, “the platform is working on a bunch of nudges to help its customers avoid breaking the basic trading rules. To help traders do well, we are working on having a bunch of nudges that will help traders avoid breaking the basic trading rules, which will improve their odds of doing well.”

Which odds? There are no odds.

In the end, there is only one winner, the casino operator.

Guess what, even the SEBI report published last year proves that 90%+ people who trade in derivatives lost money…

It’s imperative to foster an environment that emphasizes financial education, where the risks of options trading are not obscured by the glossy appeal of quick gains. Investors need to be informed about the merits of long-term investing strategies over short-term speculative trading.

Furthermore, there’s a pressing need for robust regulatory frameworks that ensure transparency and fair play, protecting the interests of retail investors from potential market manipulation and systemic risks.

Here are examples of how people lose money in F&O Trading:

Leverage Risks: F&O trading often involves significant leverage, which means a small movement in the market can lead to disproportionately large losses or gains. Investors can find themselves losing more money than their initial investment very quickly.

Complexity of Products: The complexity of options contracts can be difficult for the average investor to understand. Misunderstanding the terms and conditions, like expiration dates and strike prices, can lead to substantial losses. Hell, it’s even difficult for professional investors and professionals to comprehend…rather even they don’t understand it fully…

Volatility: Options are highly sensitive to changes in the volatility of the underlying asset. Unanticipated market moves can render options worthless at expiration, leading to total loss of the premium paid.

And who has any clue about what the stock market can do in the short term?

Time Decay: The value of options decreases as the expiration date approaches a phenomenon known as time decay. Investors not only need to be right about the direction of the market move but also the timing.

Liquidity Risk: Some options contracts may have low liquidity, making them difficult to sell at a fair price, which can result in losses when trying to close a position.

Margin Calls: If a trade goes against an investor, they may face a margin call, requiring them to commit additional funds to maintain their position, which can compound losses.

Overconfidence: Psychological biases like overconfidence can lead investors to take on excessive risk, thinking they can predict market movements, often leading to heavy losses. This is the biggest one. Most so called savvy or professional investors lose money in these trades thanks to overconfidence.

Warren Buffett famously referred to derivatives as “financial weapons of mass destruction” in his 2002 shareholder letter.

Here’s why:

Systemic Risk: Derivatives can tie multiple parties into complex financial webs. A default by one party can have ripple effects across the financial system, potentially leading to a systemic crisis.

Counterparty Risk: The risk that the other party in a derivatives contract will not fulfil their obligations can lead to significant losses, especially if the counterparty is a significant financial institution.

Opaqueness: Derivatives are often complex and not fully understood, even by sophisticated investors, which can conceal the true amount of risk being taken.

Speculation vs. Hedging: While derivatives can be used for hedging risks, they are often used for speculative purposes, amplifying risks rather than managing them. Most people use it for speculative purposes only…Period.

Misaligned Incentives: The enormous fees associated with creating, selling, and trading derivatives can encourage bankers and traders to take on more risks, sometimes risks that are not in the best interest of their clients or the economy at large.

Buffett’s criticism is largely directed at the unchecked and opaque creation and trading of complex derivatives, which he believes can create serious financial instability. He argues that while these instruments can serve valid purposes, such as hedging, their misuse and abuse can lead to disastrous economic consequences, as evidenced in the 2008 financial crisis.

In essence, Buffett warns against the dangers of derivative instruments that can amplify risks, create misleading financial statements, and ultimately, lead to economic turmoil. His advice highlights the importance of understanding the inherent risks and ensuring that these financial instruments are managed with caution and transparency.

The question we must ask ourselves is not just whether we are creating more ‘addicts,’ but whether we are doing enough to prevent this addiction in the first place. The essence of investing is to build wealth sustainably over time, not to gamble away one’s future on the unpredictable swings of market sentiment.

As we continue to grapple with this trend, it’s crucial for investors to remember the fundamental principle of finance—high returns come with high risks. It’s time to shift the narrative from making fast money to making smart money, prioritizing education, and informed decision-making in the pursuit of financial well-being.

In conclusion, while the allure of F&O trading is strong, we must collectively strive to create a culture that prizes informed investing over speculative trading. The health of the market, the prosperity of its participants, and the stability of our financial system depend on it.