Jane Street saga echoes another warning for retail option traders

A ‘secret’ strategy used by US-based hedge fund Jane Street helped it earn over $1 billion last year in options.

At the losing end for most of these trades were Indian retail investors.

At a courtroom in Manhattan, where it has filed a lawsuit against Millennium Management Global Investment for allegedly stealing its unique trading strategy, Jane Street claimed that the strategy used in India has been its most profitable one.

According to allegations by Jane Street, two of its former employees ‘stole’ the strategy when they moved to their new employer Millenium.

In India’s derivatives market, where the average daily trading volume has surged nearly two-folds to Rs 440 trillion in just a year, algorithmic trades are not new.

However, instances like that of Jane Street once again shed light on how the odds of winning are stacked against smaller investors, who enter the options trading arena given its high-risk-high-return preposition.

Apart from Jane Street and Millennium Management, several other high-frequency trading platforms like Graviton, Jump Trading, Alphagrep , Tower Capital and Citadel Securities have garnered repute for their algorithmic-based strategies in India.

These firms use complex algorithms to execute their trades and engage mostly in proprietary trading based on specific strategies, without any emotional bias. The sheer quantum of trades executed in fraction of seconds help them build on profits even if the gain on each trade is low.

There are algo and pre-defined strategies available for small investors as well. However, that doesn’t guarantee success. 

“Retail traders must understand and be educated that an algorithm or a specific strategy will not guarantee profits for them. The problem lies in misselling, mis-marketing, and inciting greed where retail traders may fall victim to false claims made by some on social media. Regulators and exchanges have been working hard in eliminating such malpractices,” said Kunal Nandwani of uTrade Solutions, an algo trading solutions provider.

Angel One said in its recent earnings call that it undertook development on the Super App with the rollout of dedicated sections for option strategies. These sections allow traders to discover and execute predefined and custom strategies easily.

“Traders see the growing market as an opportunity. However, algo platforms for retail traders are still evolving. Till the time algo-based strategies become more accessible for retail, it can remain a ‘winners take most’ market. In many other markets too, mainly the top players make money,” added Nandwani.

According to sources, the Securities and Exchange Board of India (Sebi) is mulling an additional framework to address regulatory gaps on algorithmic-based traders.

While there are basic guidelines for brokerages using such technology, there have been concerns on rising individual participation through algo-trades.

“Markets are protective to retail traders. However, persons, who have the capability to use sophisticated tools and algorithms, are punching voluminous orders. Should they, too, be covered under the protective frameworks like compensation etc? The risk and governance methodologies on these are unknown territory and discussions are on regarding how to address it,” said a person familiar with the regulatory developments.

According to a study by Sebi, done in the financial year 2021-22 (FY22), about 90 per cent of active traders incurred losses — the average being Rs 125,000. Furthermore, the average net loss of these 90 per cent individuals was over 15 times the earnings of the 10 per cent who made profit.

The report depicted the disparity among futures and options (F&O) traders. The top one per cent of traders accounted for nearly 51 per cent of the total net profit earned and the top five per cent saw 75 per cent of the total profits.