Sebi's Jane Street order: The canary our market needed

It exposed risks in India's equity market that can be mitigated if distortive regulations are sorted out

- SOMNATH MUKHERJEE

Arbitrage or market manipulation? Jane Street believes it is an uber-efficient arbitrageur. It spotted pricing anomalies between index options and the index's stock constituents, and used sophisticated trading models to profit from the arbitrage. The Securities and Exchange Board of India's (Sebi) order has some interesting findings. On 17 January 2024, the expiry day for Bank Nifty derivatives, the index opened 2% lower due to weak earnings of some of its constituents. However, options on the Bank Nifty traded at a level where the implied price was higher, resulting in an anomalous price spread. JS did what textbooks tell us: buy stocks that make up the Bank Nifty while selling options on this index. The trade worked as textbooks say it would: the spread narrowed within six minutes. But here's the twist: the total value of Bank Nifty stocks purchased was ₹572 crore while the total notional value of the options sold was ₹8,751 crore, which is more than 15 times. This oddity continued. By mid-day, JS had bought Bank Nifty stocks and futures worth over ₹5,000 crore and sold options worth over ₹30,000 crore. Arbitrage is about hedging, but one doesn't hedge a bet on India winning the Border-Gavaskar Trophy by placing 15 bets on India not-winning it. So JS started selling its stock/futures positions. But liquidity in these segments is so low that its trades tanked prices, resulting in losses for JS in its long index positions. But its large short options position (5-6 times in notional exposure to its cash/futures positions) got settled at market close at a massive profit. In short, JS appeared to move prices in the illiquid leg of the market (cash/futures) so that it could pro