Jane Street to argue that retail demand drove its India trades

The New York-based firm is expected to argue it was eager to facilitate options bets from the country’s retail investors, knowing it would be largely unhedged, said the people familiar with the matter, who asked not to be identified discussing private information. The firm hedged less in India than in other markets and spread out its hedging activity over multiple hours on that day in January 2024 to reduce its market impact, the people said it is likely to explain.

Jane Street said on Monday it has sought an extension to respond to the interim order. Reuters

On that morning, the NSE Nifty Bank Index dropped 3.2% at the open and fell further during the day. SEBI alleged that Jane Street aggressively bought the index’s constituent stocks in the cash and futures markets to manipulate the gauge’s intraday levels, then reversed the trades in the afternoon to profit from a much larger bearish index options position.

Jane Street is expected to say that high retail demand for options on that index was a key driver behind its trading in the morning, according to the people familiar with the matter. The firm will likely argue that individual traders bought about $4 billion worth of the gauge’s stocks using options in the first half hour of trading, and that Jane Street — which was acting as a market maker — facilitated about $1 billion of that demand.

Those numbers are based on net delta positions, which represent the value of cash equities the options positions are equivalent to when taking into account the derivatives’ sensitivity to the underlying assets’ price moves.

Partial Hedging

SEBI’s order said Jane Street’s share purchases on that January 2024 morning represented between approximately 16% and 25% of the trading turnover for 10 of the 12 Nifty Bank Index stocks, making the firm by far the single largest net buyer. As Jane Street sold call options and bought puts, it amassed a bearish position that represented 7.3 times the size of its long cash and futures bets, according to the regulator.

Jane Street is expected to argue that the high retail options demand created a gap between prices implied by the options and those reflected by the shares, and the firm sought to close it through a standard arbitrage trade, the people familiar said.

The retail demand was so large that only 10% of it could have been hedged — partial hedging being a common practice among derivatives market makers internationally, the firm is expected to say.

In the afternoon, Jane Street sold the stocks over more than three hours, spreading out its hedging to protect against settlement-price uncertainty as the options were about to expire, also a typical tactic globally, the people said it will argue.

SEBI did not respond to a request for comment.

Huge Turnover

Retail traders’ enthusiasm for options has helped turn India into the world’s biggest market for listed derivatives by contracts traded, with turnover of more than 300 times that of cash equities. Global trading firms have used their capital and technological edge to profit from that large imbalance, but local investors have cumulatively incurred billions of dollars in losses, leading the regulator to crack down on the trading frenzy.

Critics of Jane Street say the sheer size of its positions built up over a short time would have given the firm market-moving power, even if the trades were within regulatory limits.

Alexander Gerko, the billionaire founder of rival XTX Markets Ltd., has challenged Jane Street to show that its India trading strategy was “legit” by proving it would work better after scaling it down by a factor of a 100.

“Any ‘normal’ strategy works worse as it scales up, due to market impact, unless your strategy IS market impact,” he wrote in a LinkedIn post earlier this month.

The regulator’s interim order presented serious allegations and a “compelling narrative,” though it is not certain that Jane Street acted inappropriately based on the initial findings, said Abhiraj Arora, a Mumbai-based partner at law firm Saraf and Partners who once worked at SEBI’s surveillance and investigations department.

Arora, who isn’t involved in the case, said too harsh a crackdown and excessive surveillance of market makers could lead to wider bid-ask spreads, poorer trade execution and increased price swings.

The Jane Street case ultimately “serves as a significant test for India’s regulatory framework and its capacity to oversee increasingly complex global trading practices,” he said.