Badla trading nostalgia has nothing to justify it

It allowed traders not to settle their trades within the timeframe they were meant to be settled on a cash basis, but carry them forward by paying a small badla fee for that benefit.

What replaced it was the global practice of using derivatives like futures and options (F&O), contracts that let traders hedge their bets or speculate on future price movements.

Fans of badla argue the stock market back then had such large volumes and high liquidity that big-money players could not expect to push stocks up or down as part of a game.

In a market marked by low supply of free-float shares, with vast chunks of equity held by company promoters, the split-up of trading into cash and F&O segments has enabled outsized gains in the latter through price-moving trades in the former. Or so goes the argument.

The ban on badla was resisted by lobby groups as there existed entities focused on financing it. The rates they charged were not just opaque, they varied by the security and trader in question, apart from liquidity conditions in general and of the stock at any given time.

The badla system was flawed in other ways too and its record suggests that leveraged plays aimed at price rigging were rampant. Critically, the claim that badla kept liquidity higher is spurious: cash or spot transactions being rolled over to the future combined cash and speculative trade volumes, which only lent it that appearance.

Today, hedging and speculative trades are visible in F&O data. To compare liquidity back then with now, we cannot stack up pre-2001 spot-plus-badla trades against today’s spot trades; a comparison would have to either eliminate the speculative element in badla-era trade volumes or add F&O with spot trades to size up the current scenario.

Even with badla, only free-float shares were in play; but traders in those days could place large bets that would distort prices to manufacture an advantage. The present era of quick T+1 or T+0 squaring-up is significantly more efficient (and thus fair).

Indeed, all considered, India is better off with a clear separation of spot and forward deals. As this is what investors are globally familiar with, it draws their participation and helps deepen our market. For India to attract risk capital, we cannot revert to a discredited practice like badla.

This is not to say that the F&O segment is a paragon of perfection. In recent years, it has been swamped with retail participants who seem clueless about the purpose of these contracts.

The classic saying about fools and their money being parted seems to ring true in the Securities and Exchange Board of India’s (Sebi) finding that nine of every 10 derivative traders make losses.

The zealous participation of rookies who have never heard of the Black-Scholes pricing formula for options only makes it obvious that they see the F&O space as a legal casino of sorts. Sebi has done well to increase the lot size for F&O trading, placing it beyond the reach of casual traders.

As with casinos, though, higher ticket prices can fail to deter addicts looking for the thrill of an occasional lottery-like win. All this points to a need for investor education and efforts to deepen the cash segment. Why hark back to the past?