Resisting the quick buck

NAQUAINT village, a small market for curd thrived, where buyers paid upfront in cash. Alongside, there was a bustling derivatives market for future curd deliveries, where participants paid only a small margin upfront. Prices in both were interlinked, but the derivatives market dwarfed the spot market in trading volume. This setup attracted quick-money addicts—speculators chasing a "zero to hero" trade, gambling in the derivatives market.

- NILESH SHAH

Enter a wealthy merchant from outside. Noticing the high trading volumes, he flexed his financial muscle, buying large quantities of curd in the spot market in the morning and driving up prices. The derivatives market followed suit, with curd futures prices soaring in tandem. By afternoon, the merchant escalated his game. He sold call options on curd at inflated prices, signaling to the market that prices would keep rising, while simultaneously buying put options at lower-than-market prices.

Quick-money addicts, lured by the steady price uptrend and convinced of further price rises, jumped in. They sold out-of-the-money put options at low premiums, hoping to pocket the premium for quick profits. Some bought deep out-of-the-money call options at low premiums, hoping that prices will rise to astronomical levels.

But late in the afternoon, the merchant pulled the rug. He dumped his curd holdings in the spot market at throwaway prices, causing a sharp collapse in both spot and derivatives prices. The quick-money addicts faced devastating losses. The merchant, while incurring some losses on his spot market sales, reaped massive profits in the derivatives market. Week after week, the merchant repeated this cycle at the village market, amassing wealth while the addicts suffered crushing losses. Eventually, the village market head caught wind of the scheme and ordered the merchant to repay his ill-gotten gains.

This story mirrors the Securities and Exchange Board of India's (Sebi) recent order against Jane Street, a high-frequency trading (HFT) firm. On April 13, 1919, thousands of unarmed Indians were killed in Jallianwala Bagh. In our futures and options (F&O) markets, a similar massacre occurs every week, where millions of Indians get killed economically, not by bullets but by their greed. Sebi warns that nine out of 10 speculators lose money. Unfortunately, all 10 believe they belong to the winners' category.