Traders ditch derivatives for broker-funded stock bets

Retail and wealthy investors are gradually moving away from derivatives trading and turning to broker-funded stock purchases, as higher costs and tighter regulations make derivatives less attractive.

The shift is evident in the rapid growth of margin trading facilities (MTFs), in which brokers lend clients money to buy stocks. To be sure, the sharp growth comes on a low base. The industry-wide MTF book on the National Stock Exchange (NSE) has surged 52% from a year ago to ₹1.51 trillion as of September-end, even as trading activity in index and stock futures has slowed sharply.

Shares traded on the NSE accounted for 95% of the industry-wide MTF book, with those on BSE accounting for the rest, per exchange data.

Brokerages such as Angel One, Groww and HDFC Securities say more clients are choosing leveraged cash-market positions, which offer a simpler alternative to futures contracts and avoid the hassle of mandatory expiry-day rollovers.

The lending rate is an annualized 9-12% and up to 14% in certain cases, brokers said, while cost of funds to brokers through commercial paper issuance for up to a year is 7-7.5%. This enables brokers to earn a neat spread.

All large brokers fund the margin for clients who want to buy a certain stock but can't afford to purchase large quantities to benefit from a rise in the stock over a few weeks to months.

Most brokers fund 60-70% of the margin required to buy a stock, with the client covering 30-40%, depending on a stock's pedigree and volatility.

The risk of a correction is offset by the client's margin. Any shortfall results in a margin call by brokers which, if not met, results in brokers closing out the leveraged positions.

The benefits are thus reshaping brokers' earnings. With lower trading activity weighing on brokerage income during excessively volatile periods like the recent September quarter, growing MTF books are helping firms offset at least some of the shortfall in broking income.

Futures trading activity has declined sharply. Average daily turnover in index futures fell over 30% year-on-year to ₹15,578 crore in September, while stock futures turnover dropped below ₹1 trillion after falling 14% from a year ago and 19% from June.

Stocks being purchased through MTF include the likes of HDFC Bank, Reliance Industries, Sun Pharma, Tata Capital and BSE.

The gradual shift is evident at Angel One, where the MTF book grew to ₹8,210 crore by September-end, up 14% from June and 37% from a year earlier. The broker added 72,000 MTF clients during the period.

At Groww, the MTF book increased 15% from June and 2.6x from a year ago to ₹4,351 crore, while the number of active MTF users remained stable at 1 lakh.

Anand Rathi Share and Stock Brokers has added over 1,000 clients on the MTF side since June.

"We are witnessing a gradual structural shift in retail participation towards cash equities and margin-funded investing. One of the important factors has been the increase in minimum derivatives contract sizes, which has significantly raised the capital commitment required from retail participants. This, together with the rationalization of weekly expiries, tighter regulatory safeguards and higher transaction taxes, has altered the economics of derivatives trading, " said Dinesh Thakkar, chairman and managing director at Angel One.

Broking officials like Thakkar believe client funding activity could get a further boost, with Sebi likely to expand permissible funding sources from short-term CPs to longer-term non-convertible debentures (NCDs) for beyond a year.

"We are witnessing a gradual shift in client participation from derivative futures towards MTF, as investors explore leveraged equity positions with greater flexibility and without the complexities of futures expiry and rollover," said Dhiraj Relli, managing director and chief executive officer of HDFC Securities, the seventh largest broker by active clients.

Relli cited issues such as clients forgetting to roll over futures positions at expiry being forced to take delivery, which they might not want, since all stock derivatives are compulsorily deliverable.

Any risk of a stock price decline is covered by haircuts, or margins, posted by clients. In the event of a stock price decline and a client's failure to top up his margin, the broker liquidates the position to prevent risk.

The fall in equity brokerage revenues is partially offset by MTF revenues in Q2FY27.

Stock brokers’ core revenue source, equity brokerage, is declining while income from MTFs is increasing.

For Groww, revenue from MTF as a percentage of total income increased to 10.1% in Q2FY27, up from 8% in the previous quarter.

For Angel One, interest income as a percentage of total gross income grew to 36% in Q2FY27 from 33% in the previous quarter. Interest income includes revenue from MTF and may also include interest from the company’s own treasury.

Equity cash and derivative volumes have fallen during the quarter also due to a fall in participation since the introduction of the closing auction session (CAS) on 3 August and partly to traders moving to crude derivatives on MCX.

However, the CAS issue is now resolved; as of 15 October, Sebi has held back for a year, effective 7 December, the auction price settlement mode of derivatives contracts. These contracts will settle on monthly and weekly expiry days on Tuesdays and Thursdays at the volume-weighted average price of the underlying stocks.