Jane Street: A Regulatory Challenge

On 3^rd July, the Indian capital market regulator, the Securities and Exchange Board of India (SEBI), created a storm in the market by taking the most stringent action ever against a foreign trading firm: it barred one of the world’s largest quant trading firms, Jane Street, from accessing India’s securities market after an investigation found it made “unlawful gains”.

Rightfully declaring that, “the integrity of the market and the faith of millions of small investors and traders, can no longer be held hostage to the machinations of such an untrustworthy actor”, SEBI, under its interim order, also impounded $ 567 million (Rs 4843 crore) as alleged unlawful gain from New York-based Jane Street.

First things first: Jane Street operates in the Indian market through four group entities, of which two are based in India, while the other two are based in Hong Kong and Singapore. These two Asian units operated as investors registered with India. The interim order of the SEBI states that between January 2023 and March 2025, the four entities cumulatively made a profit of $5 billion by trading in equity options in India.  

Incidentally, the scale of operations of Jane Street came to light in 2024 when the firm sued a rival hedge fund, Millennium Management, accusing it of stealing its valuable in-house trading strategy.  The court proceedings revealed that this strategy was employed by Jane Street’s option trading in India, which generated $ 1 billion in profits for it in 2023.   It is, of course, a different matter that the case was eventually settled between the firms, but the terms of settlement were not disclosed. Intriguingly, much of the detail about the actual trading mechanics and proprietary methodology of Jane Street that gave a profit of $ 1 billion remained confidential within the court filings.

Nevertheless, the investigation carried out by SEBI did reveal Jane Street’s overall trading conduct and profit mechanics in India. As a group, Jane Street first aggressively bought significant quantities of banking stocks and futures in the morning trading session, temporarily pushing up the Bank Nifty index and simultaneously suppressing its put option prices. Then, it built large short positions – primarily put – in bank index options. These option positions were unusually larger than their stock and futures positions, which is not a genuine market-neutral index arbitrage. Later, shortly before the closure of the market, it aggressively sold large quantities of the same banking stocks and futures to exert downward pressure on the Bank Nifty index.

This “marking the close” strategy caused the Bank Nifty index to decline, making Jane Street’s previously acquired put options significantly more valuable. As put options are cash-settled at expiry, Jane Street’s profits were realized as the closing price was sharply lower than their put strike prices. And, the profits from these options vastly outweighed any losses sustained from selling the stocks at lower prices than bought them for in the morning. Interestingly, Jane Street managed to “work around” Indian regulations that prohibit foreign portfolio investors from undertaking intraday positions in the cash market by carrying out its day trading through its Indian-incorporated entities, such as JSI Investments Private Limited.   SEBI noted that Jane Street repeated this coordinated pattern of trading mechanism, especially on expiry days of options—a critical input for options settlement – and reaped huge profits. This ‘manipulative strategy’ continued uninterrupted till SEBI banned their operations in the Indian market.

Now the question is: How could Jane Street carry on with its market manipulation for this long?  The answer is: Slow regulatory response and inadequate surveillance mechanisms. Despite recurring large-scale trading patterns, particularly across multiple expiry cycles, regulators failed to flag these as potential red flags.  There was also a lack of effective inter-agency coordination: NSE closed its internal probe, accepting Jane Street’s formal assurances of compliance, even though patterns of aggressive “marking the close” trades were evident.   Even SEBI relied on these formal statements rather than adopting a proactive regulatory stance until as late as 2025. Structural flaws in the market, such as: lack of well-defined market share thresholds that would automatically trigger regulatory audit, reliance on end-of-day weighted average pricing for options settlement, and skewed and ill-liquid index composition created systemic vulnerabilities. Cumulatively, they allowed Jane Street to operate its manipulative trading unchecked for far too long and reap huge profits at the cost of gullible retail investors. 

That aside, SEBI has recently permitted Jane Street to resume trading in Indian stock markets after the firm deposited $567 million in an escrow account. Both NSE and BSE were, of course, asked to maintain close surveillance of its activities. At the same time, Jane Street, while asserting that their actions are within the legal framework, stated that they have deposited the amount “without prejudice to their rights and remedies which remain available to them in law and equity”.   That being the undertone of Jane Street, one has to wait for the final order of SEBI to know the future trajectory of India’s derivatives market.

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Oracle Bows to Age: ‘Adapt to what you can’t’

 

On May 3, 2025, 94-year-old Warren Buffett announced his retirement as CEO of Berkshire Hathaway at its annual shareholder meeting, surprising many.

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Warren Buffett, the legendary investor known for his preternatural value investing, who previously said that he had no intention of retiring, realized that the time had come “to act fast” and announced that he would step down as CEO of Berkshire Hathaway at the end of 2025 and pass on the baton to Greg Abel, Vice Chairman, who is currently overseeing Berkshire’s non-insurance business.

In 1965, Buffett acquired Berkshire Hathaway, a struggling textile manufacturer, and transformed it into a global conglomerate holding company that manages a diverse range of businesses and investments. Its main business is insurance—both direct and reinsurance. He turned it into the world’s biggest reinsurer. It also manages freight rail transportation and utility and energy distribution. Besides these core businesses, the company also owns dozens of well-known consumer-oriented companies in various sectors. It also has significant stakes in other publicly traded companies. 

Buffett’s entrepreneurial journey started quite early in life. As a school-going boy, Buffett started investing in stocks with the money earned by delivering newspapers. It is at Columbia University that he mastered the art and science of valuing stocks under the mentorship of the legendary Benjamin Graham—“father of value investing”. Since then, he has spent his lifetime in search of businesses that offer scope for growth and stability. 

Buffett said that all through his investment career, he has practiced a cardinal principle: Never invest in a business that you don’t understand its business model. He is known for being wary of investing in technology firms, simply because he claims not to understand the tech business. Intriguingly, he doesn’t own any stake even in Microsoft, although he has partnered with Bill Gates on the bridge circuit. 

As is well known, insurance businesses generate large volumes of cheap cash in the form of premiums collected. While the insurance business is in itself a very profitable one, it is the wise deployment of that cash by Buffett in the stock market that has made Berkshire consistently generate high returns from the investments. Today, the company enjoys a market value of $1.08 tn plus. Berkshire Hathaway is now the world’s eighth most valuable company. Buffett’s personal stake in the company stood at around $168 bn, making him the world’s fifth-wealthiest man.  

Buffett’s investment philosophy is pretty transparent. As a well-known value investing strategist, he did not participate in the dotcom boom of the late 1990s, for he thought that those companies were overvalued based on speculation rather than financial performance. Thus, he was able to avoid the kind of heavy losses that many other investors suffered when the dotcom bubble imploded in the early 2000s. 

Buffett claims that the secret of his investment strategy is: Patience. He patiently waits until he thinks the price is right to buy a stock. As and when the price is considered right by Berkshire, it will buy a big stake and allow the incumbent management to carry on the business with little or no oversight from it. 

Buffett’s sharpness in understanding complex financial business models is well reflected in the portfolio that he builds up, mostly driven by his own financial valuations. Berkshire’s investment portfolio predominantly includes consumer-centric businesses such as Coca-Cola, Bank of America, and Apple, besides a substantial stake in the financial sector. 

Eugene Fama, a Nobel Laureate in economics from the United States, proposed the Efficient Market Hypothesis (EMH), which suggests that stock prices fully reflect all available information, making it impossible to consistently outperform the market. The theory posits that if all information is instantly and accurately incorporated into stock prices, there is no way to find undervalued stocks or consistently beat the market through expert stock selection or market timing, except perhaps by buying riskier investments. It essentially means that one can earn only market-average returns unless one has access to non-public information. But Buffett has challenged the EMH through his value investing approach, which focuses on identifying undervalued stocks and holding onto them for a long time. His Berkshire Hathaway’s annualized return on investment during 1965-2024 is estimated to be around 19.9% as against 10.4% of S&P 500 annualized return for the same period. 

Buffett used to share his deep insights and the sharpness of his stock-picking strategy in the form of aphorisms couched with humor through his letters to shareholders, as also in his address at the annual general body meetings. He once cautioned investors, saying, “If you are trying to trade on headlines or time the market, you are not investing—you’re gambling”. 

In 2003, Buffett shared his opinion against derivatives through Berkshire’s annual report: “In my view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal”. He also highlighted the potential of these complex instruments to cause systemic risk, particularly due to opaque pricing and accounting practices. He even said: “... the parties to derivatives also have enormous incentives to cheat in accounting for them”. And come 2008, the collapse of AIG, a major issuer of Credit Default Swaps (CDS), and the global economic crisis proved how prophetic Buffett was. 

Once Buffett saying, “the risk-averse investor is the poor investor”, encouraged retail investors to take calculated risks, but only in areas where one has a good understanding of the business. One of his famous pieces of advice is: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”. 

Backed by long years of experience gained from Wall Street, he once gave a sagely advice to the retail investors: “Volatility is a feature of stock markets, not a bug”. He summarizes that in the next 20 years, there may come a phase that will be a “hair curler” compared to anything we have seen before. Such events keep recurring, and these typically unfold in dramatic ways. But that is just the way of the stock market. This unpredictability makes the stock market a great place to invest in, but only if one has the temperament for it. On the other hand, it is not a good space for those who get frightened by markets that decline and get excited when stock markets go up.

On Donald Trump winning the elections, most of the stock market participants turned euphoric and the US equities, bonds and currency markets rallied strongly immediately after the results. But the Oracle of Omaha, turning more oracular, and guessing that once Trump starts fulfilling campaign promises, markets may face turmoil, Berkshire Hathaway sold its profitable positions. Strategically, it sold more shares than it bought in 2024, and as a result, it is sitting on cash and cash equivalents and short-term investments of $333.3 bn in December 2024, which is almost double the cash reserves—$167.5 bn—held in December 2023. 

As perhaps wary of market uncertainties stemming from Trump’s tariff war, Buffett appeared to prefer investing in low-yielding US Treasury bills rather than stocks. In uncertain times, cash can serve as a handy cushion—and times have rarely been as uncertain as during the ongoing tariff-mayhem. However, some analysts argue that clinging to such a large cash reserve carries a significant opportunity cost, leading them to question the legendary investor’s decision to stay away from Wall Street. 

However, in his annual letter to shareholders of Berkshire Hathaway, Buffett addressed this dilemma: “We are impartial in our choice of equity vehicles, investing in either variety based upon where we can best deploy your (and my family’s) savings. Often, nothing looks compelling; very infrequently, we find ourselves knee-deep in opportunities”. This candid approach is one of the admirable traits of Berkshire Hathaway and its Chairman, who openly discusses the company’s challenges and decisions in his annual letters to shareholders. 

Enriched by decades of experience in the investment world, Buffett sounds very forthright when he says, “The problem with the investment business is that things don’t come along in an orderly fashion, and they never will”. He goes on to say that “Berkshire holding large amounts of cash isn’t out of fear but out of discipline and patience, waiting for good opportunities. When those come, having the cash to pounce on the opportunity matters”. 

This legendary investor’s philosophy of philanthropy is “grounded in his belief that those with great wealth have a responsibility to give back to society”. His philanthropy is characterized by unprecedented scale and a focus on effectiveness. He preferred to give donations to existing foundations rather than starting new ones. He has been the largest individual donor to the Gates Foundation, contributing over $43 bn as of 2024. With a lifetime charitable giving that exceeds $56 bn, Buffett stands as one of the top philanthropists. He pledged to give away 99% of his remaining wealth to a charitable trust managed by his three children after his death. 

That is Buffett and his investment philosophy. This philanthropist’s impending retirement will mark the end of an era. His philanthropy, however, blooms forever.

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Trading in Equity Derivatives: Can SEBI Rein in Animal Spirits?

Alarmed by a substantial increase in turnover and the number of contracts traded in Futures and Options (F&O) at BSE and NSE—the combined turnover at these two exchanges surged more than fourfold between May 2022 and May 2024, reaching Rs 9,504 lakh crore—and viewing it as a potential threat to capital formation and economic growth in the country, SEBI and RBI have expressed their concern.

In most markets, derivative trading volumes average 5-15x of volumes in the cash market. As against this, derivative volumes in India have already touched 400x of cash trading. The gravity of the situation can be gauged from the fact that Germany, the second in the line stood at 36x of its cash market. The Chairperson of SEBI commented that Rs 50-60 thousand crore was going away from household savings into losses in the F&O segment. It has thus become a major macroeconomic issue.

Before going deeper into these losses and their consequences, let us first look at what these derivatives are and why rapidly growing trading in derivatives is disturbing market regulators. Derivatives are financial instruments whose promised payoffs are derived from the value of something else, generally called the underlying. The underlying could be stocks, commodities, currencies, or even indexes. They are essentially designed to hedge or contain certain risks.

One of the derivatives is Futures. It is one of the oldest innovations in the financial world. Since the times of Aristotle, futures have become the darling of market players —hedgers, speculators, and arbitrageurs—as they are found to mimic the price of the underlying asset better.  better. A financial futures contract is an agreement between two parties to buy or sell a standard quantity of a specific financial instrument at a future date at a price agreed upon today between the parties through an organized futures exchange, say NSE/BSE.

Under a futures contract, a buyer commits today to buy Reliance shares at a specified future date at a price fixed today, and the seller makes the opposite commitment.  A buyer thus acquires a long position while the seller acquires a short position. When a position is acquired, both parties are required to post an initial margin with the exchange. Thus, futures trading facilitates leverage on margin, i.e., it enables investors to take large positions with a small initial outlay of funds. If the price of the underlying moves in the unintended direction, a trader may lose more than the initial margin. Trading in futures thus can lead to either larger returns or larger losses.

The second most actively traded derivative is the Option. The buyer of an option has the right but not the obligation to take delivery of the underlying asset. On the other hand, the seller of an option must perform the contract, should the holder/buyer of an option exercise. The buyer of an option must pay a certain fee known as option premium to the seller to enjoy the liberty of this right.

Options are of two types: call option, which gives the right to buy the underlying asset, and put option which grants the right to sell the underlying asset at the agreed upon price. Let us take an example to understand how options operate. Say, X company’s share is priced today at Rs 500 and you expect it to increase to Rs 670 by a certain predicted date. In this scenario, you must purchase a call option with a strike price of less than Rs 670. On the expiry date, if the price of the X share is above the strike price, you will exercise the option and make a profit. On the other hand, if the market price is lower than the strike price, you will not exercise the option. The net result of letting the option lapse is the loss of the premium paid earlier to purchase the option. Option trading thus provides scope for higher returns with a lower margin (option premium). This leverage can also multiply potential losses.

Perhaps, it is this potential for higher gains offered by the leverage that is luring retail investors towards speculative trading in derivatives. A recent study carried out by SEBI revealed that 93% of retail investors in the F&O segment made losses. The study also pointed out that it is the foreign portfolio investors and brokers trading on their proprietary books who are raking in profits owing to their deep pockets and the ability to use sophisticated algorithmic trading tools.

Authorities conclude that trading in the F&O segment is hurting individual traders badly. Here, it is also worth recalling what Warren Buffett once said: “Derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal”. Indeed, derivatives are essentially tools used by organizations to hedge against price risk. But ironically they have today become products to trade. Gullible individuals, being unaware of embedded risks in derivatives trading and lured by brokers with promises of riches, are burning their pockets by trading in derivatives.

Against this backdrop, SEBI constituted a 15-member working group headed by Padmanabhan to “suggest near-term and medium-term measures to enhance investor protection in exchange-traded derivatives and to improve risk metrics and risk architecture of ETDs, with a view to enhance market development and regulation”.

Accepting most of the group’s recommendations, SEBI increased the minimum contract size for index futures and index options from the current Rs 5-10 lakh to Rs 15-20 lakh and also mandated upfront collection of option premiums to reduce speculative positions. In an attempt to rationalize weekly index derivatives, it allowed exchanges to offer only one benchmark index with a weekly expiry.

SEBI is also introducing intraday monitoring of position limits, and increased tail risk coverage to address the likelihood of losses from rare events. To address the significant trading volumes noticed on expiry days and the potential basis risks thereof, SEBI said that the benefits of offsetting positions across different expiries (calendar spreads) will not apply on expiry days. According to the SEBI circular, these measures, which are meant to protect investors and maintain market stability, will come into force in a phased manner starting November 20, 2024.

No wonder, there would be strong opposition to these changes from exchanges and brokers for they will impact their business adversely. It is to be seen how SEBI steers through it. Secondly, one wonders if these changes can rein in investors’ animal spirits! 

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