Sumedh Gadham and Tarang Rathi

Source: Reuters

In this piece, the authors explore Jane Street’s recent trading activity in the cash and options markets and SEBI’s regulatory approach to inter-market arbitrage. They use Kelkar-Shah’s framework of market failure to identify that the site of intervention should be the cash markets, and not the options market. They propose three policy measures to correct the market failure in the cash market. These policy measures are, it is argued, preferable to SEBI’s regulatory agenda in the aftermath of Jane Street’s run-in with the regulator.

On July 3^rd, 2025, the SEBI passed an ex-parte interim order against the global trading firm Jane Street (JS) for intra-day index manipulation, alleging unlawful gains of INR 4,843.57 crore. SEBI identified two primarily manipulative strategies employed by JS to distort index prices and profit from index options, particularly on expiry days: “Intra-day Index Manipulation” and “Extended Marking The Close”. These strategies exploited the inherent interrelationship between derivatives and their underlying assets, along with the significant liquidity differences between the options and cash & futures markets.

This post argues SEBI’s regulatory agenda should focus on enhancing cash market liquidity, rather than reducing options market liquidity. To make this argument, this post proceeds in five parts. Part I seeks to explain the modus operandi of Jane Street’s trades. Part II explains the structural reasons why Jane Street could do what it did. Part III introduces and explains the Kelkar-Shah framework for identifying when coercive regulatory action should be undertaken. Part IV then uses this framework to explain why SEBI’s current reform agenda is unsuited to its own goals, and proposes an alternative, with three specific policy proposals to improve the working of cash, futures, and options markets in India. Part V concludes the piece 

Part I: An Exposition of the Jane Street Saga and the Regulator’s Approach

The “Intra-day Index Manipulation” strategy, as employed by JS, was carried out in two patches. In Patch I (during the first half of the day), JS aggressively purchased significant quantities of BANKNIFTY constituent stocks in the cash market and their corresponding stock futures. These purchases were substantial enough to support or artificially push up the prices of these constituents and, consequently, the BANKNIFTY index itself. Simultaneously, during this patch, the JS Group built very large bearish positions in the more liquid BANKNIFTY index options by buying put options and selling call options. These options positions were notably larger, for instance, 7.3 times the size of their long equity positions on January 17, 2024. This allowed JS to enter option trades at highly favourable prices, as the artificial index rise misled market participants with inflated call option premiums and subdued put option premiums.

In Patch II (from noon to 3.30 p.m.), JS reversed its earlier positions by aggressively selling almost all the cash and futures positions accumulated in Patch I. This aggressive selling created significant downward pressure on the BANKNIFTY constituent stock prices and, by extension, the index. Although JS incurred an intraday loss on these underlying cash and futures trades (e.g., INR 61.6 crores on January 17, 2024), this loss was deliberately undertaken as part of the manipulative scheme. The purpose of these underlying trades was to engineer the index’s movement, allowing the JS Group to profit immensely from their much larger, pre-established bearish positions in the BANKNIFTY index options, which gained substantial value as the index declined.

The “Extended Marking The Close” strategy, involved a more concentrated effort towards the end of the trading session. After maintaining a relatively passive or neutral trading stance for most of the day, the JS Group would aggressively intervene in the underlying index constituent stocks and futures in the final 45-60 minutes before market close. This concentrated burst of large buy or sell orders was specifically designed to influence the closing price of the index in a direction favourable to their large, pre-existing positions in weekly expiring index options. For instance, on July 10, 2024, JS aggressively sold approximately INR 2,800 crores worth of BANKNIFTY-related stocks and futures in the final hour, to depress the index’s settlement price, benefiting their INR 44,153.87 crores of effective bearish options positions. Conversely, on May 15, 2025, a bullish variant was observed where JS aggressively bought NIFTY index and constituent stock futures to push the index upward, aligning with a large positive delta exposure of over INR 55,422.76 Cr in NIFTY options.

JS effectively exploited the significant disparity in liquidity and participation between index options and their underlying cash and futures markets, especially on weekly expiry days. Index options markets are characterized by far higher volumes and participation than the underlying constituent stocks and futures markets. For example, on January 17, 2024, the cash equivalent traded turnover in BANKNIFTY options was 353 times that of its constituent stocks in the cash market and 98 times the combined turnover of cash and futures markets for its constituents and index futures.

This difference creates an environment where options offer enormous “leverage” allowing market participants to take on substantial cash-equivalent exposure with a relatively small capital outlay. Many traders in index options do not participate in the underlying cash or futures markets and instead rely on the visible index movements, which are determined by the smaller volumes and fewer participants in the underlying markets, to price and view options.

Part II: ‘Deep’ and ‘Shallow’ Markets

What The ‘Depth’ of Markets Mean

In the aftermath of SEBI’s interim order against Jane Street, there has been commentary on the Indian cash market and futures market being ‘shallower’ than the Indian options market (which can be found here, here, and here). Whilst it is true that options markets everywhere around the world are deeper than their respective cash and futures markets (this in the very nature of how an options contract operates, making it more accessible). In India, the difference has reached unusual levels. For instance, the notional value of derivatives traded in India in 2023 was 422 times the cash markets, whereas it was only between five and fifteen times in developed markets.

To appreciate this, it is important to understand what the depth of markets means. Depth and liquidity are used interchangeably here to mean a market where assets can be quickly bought or sold without causing a change in the general price of such asset in the market. This happens because the number of buyers and sellers is large, and transaction costs are low.

Explaining The Difference In Liquidity In Indian Cash, Futures and Options Markets

As highlighted above, the Indian cash and futures markets are highly illiquid vis-à-vis the Indian options market. This is because of three reasons. 

First, entry barriers are higher in the cash market than in the options market. This is because the cost of buying a share is its entire value, whereas the cost of buying an option is only the premium for the contract, rather than the value of the underlying asset itself. Options premiums are orders of magnitude cheaper than the price of the underlying shares.

Second, risks, at the level of individual investors, are lower in the options market than the cash market. This is because buyers of shares face the risk of losing the entire capital invested in buying shares, whereas the potential losses of options traders are limited to the premium they have paid (which, as we have seen above, is far less than the price of the share).

Third, the extant regulatory framework has introduced perverse incentives for traders to prefer the options market by making trading in the cash and futures markets more cumbersome. For instance, physical settlement was made mandatory for futures transactions in 2018, widening the liquidity gap between the futures and options markets. At the same time, the Securities Transaction Tax (‘STT’) penalises cash market transactions. This is because it is applied on the entire value of a cash transaction, but only on the value of the premium in case of an options trade. This subject shall be the subject of more detailed analysis later.

Part III: A Framework for Regulation post-jane street

A. Why A Framework is Needed

As explained above, Jane Street’s actions in orchestrating cross-market arbitrage (or manipulation, in SEBI’s view) has caused a flood of commentary asking for measures to temper the liquidity of the options markets in India. However, regulatory action is fraught with danger, particularly for countries with underdeveloped capital markets. Regulators risk “killing” an emerging market.

We do not dispute that all regulatory actions, including SEBI’s response to Jane Street’s actions, require a balancing exercise of the costs and benefits of such an action. This is a widely-shared view, including within SEBI, given the twin warnings sounded out about the dangers of not taking action as also the pitfalls of overregulating an emerging market. However, without a conceptual framework to concretise how regulatory costs and benefits play out, calls for “striking the right balance” are simply tautologies. We therefore propose one framework within which regulatory action can be evaluated.

B. The Kelkar-Shah Framework For Regulatory Action

By definition, regulators employ the coercive power of the State to correct what they believe to be the free market’s failures. The question to be asked is: when should regulators intervene?

Ajay Shah and Vijay Kelkar, two prominent Indian public policy intellectuals, have proposed a framework to answer this question. Building on research in Indian regulatory theory, they identified four sites of free-market failure, where State intervention might have more benefits than costs. While each of the terms used also have colloquial usage, we use them in their technical, economic sense. These are as follows.

First, public goods. These are goods that are: (a) non-rivalrous (in the sense that one person consuming them does not diminish their utility for another person), and (b) non-excludable (in the sense that the costs of excluding someone from the enjoyment of these goods is prohibitive).

Second, information asymmetry. This occurs when one party (usually the consumer) faces inordinate costs in getting access to information about the quality and price of the goods and services they wish to buy. A classic example is medicines. It is prohibitively expensive for individual consumers to test the drugs that are available on the market. Therefore, the State sets up a national drugs approval process (such as the Drugs Controller General in India, who has the power to approve drugs for sale in the Indian market).

Third, negative externalities. These refer to harms or benefits that are imposed on individuals without their permission. For instance, a factory that pollutes the air imposes the negative externality of additional carbon emissions on the residents of the area of its operation.

Fourth, market power. This refers to markets where a few buyers or a few sellers enjoy a dominant position in the market. As an example, a monopoly market allows a firm to price its products to its own satisfaction because consumers have no other firms to switch to.

Part IV: Proposals for Reform That Use Minimal Coercive Force

A. Why SEBI’s Reform Agenda is Unsuitable for Its Own Goals

SEBI’s reform agenda in the aftermath of its order against JS has looked to reduce the liquidity of the options market. This has been done mainly with a view to reduce the number of retail investors in the market. As previous analysis has shown, up to 93 percent of these investors incur net losses in options trading. But this fails the cautionary principle introduced by Kelkar & Shah, which advises non-intervention unless a market failure is identified.  Manipulation, which is the charge against Jane Street, has been delt with in a catena of cases by Indian courts and regulators. In SEBI v. Rakhi Trading Pvt. Ltd., the Supreme Court held that preplanned trades that lead to consistent losses (similar to JS’ losses in the cash market) is a clear indicator of manipulation. The SEBI has also regarded trading to create artificial volumes in the market as another telltale sign for market manipulation. It then stands to reason that market manipulation, if it did occur, had to have occurred by way of Jane Street’s manipulative hold over the movement of prices. But is this borne out by the evidence?

Yes and no. The modus operandi of Jane Street was to influence the prices of stocks in the cash market, not the prices in the options market. This means that a dominant position (and therefore the market failure of market power concentrated in the hands of a single player), if any, exists in the cash market. This, therefore, is the correct site of intervention, given that prices of BANKNIFTY constituent stocks did actually move after Jane Street trading activity. This means that SEBI has not been successful in identifying the correct market failure for these particular circumstances.

However, not only is SEBI’s reform agenda not grounded in an identifiable economic theory that justifies regulatory action as taken , it might also perversely cause certain unintended consequences. These can be explained in terms of the twin purpose of an options market: price discovery and risk management. By SEBI’s own admission, it believes that both of these are important goals for developing India’s capital markets, but both price discovery and risk management are impaired by a reduction of liquidity, which is SEBI’s current approach. Moreover, far from limited to the options market, SEBI’s current regulatory philosophy carries consequences for the cash market as well. Research has shown that reducing the liquidity of the options market also reduces the liquidity of the cash market, a consequence that runs exactly opposite the grain of SEBI’s reforms, which are aimed at reducing the difference in liquidity between the cash segment and the options segment.

An Alternative Reform Agenda

We propose an alternative reform agenda, geared to reducing the gap in liquidity between the cash and options segment, not by reducing options market liquidity, but by enhancing cash market liquidity. This is because, as stated above, the market failure exists in the cash market where Jane Street’s trading activity actually influenced prices (an indication of their market power in this market).

We propose three changes in the regulatory and tax policy in the securities market.

First, the rationalisation of the STT. Presently, an STT of 0.2 percent is levied on every transaction where shares are bought or sold—even if the buyer or the seller makes no profit from their transaction. In contrast, an STT is levied only on the premium paid for an option. It has been shown, therefore, that an STT reduces liquidity in the cash markets. This means that our current STT regime encourages trading activity in the options segment, at the cost of the cash segment. Hence, the STT on cash market transactions should be abolished, or, failing that, lowered. This will promote higher trading volumes and thereby enhance the liquidity of the cash market. At the same time, any potential loss of revenue is not significant enough. Even in countries with highly developed securities markets such as the United States and the United Kingdom, STTs enjoy little revenue potential. In fact, by increasing trading costs, they reduce capital gains and therefore also cause a fall in the revenue gained from capital gains taxes.

Second, allowing cash settlement for futures. When futures contracts are traded, there are two ways of settling transactions. The first way is cash settlement (where the trader receives the net credit or debit from the trade). The second way is physical settlement (where the trader receives the delivery of the actual underlying asset). SEBI prohibited the cash settlement of futures transaction in 2018, arguing that it needed to prevent excessive speculative activity. However, now that there are new risks of pre-concerted arbitrage activity, bordering on manipulation, between a highly liquid options market and a highly illiquid cash and futures market, this move should be reconsidered. Allowing cash settlement would make futures market trading more attractive, thereby reducing the liquidity gap between the futures and the options markets.

Third, relaxing eligibility norms for traded stock to be included in the derivatives segment. SEBI maintains eligibility criteria for single stock and index stocks to meet for them to be traded in the futures and options segment and India’s eligibility norms are among the most restrictive in the world. Allowing stock to be included in the derivatives segment improves its liquidity in the cash segment, and the more stock that is allowed the benefit of corresponding options and futures trades, the better the overall liquidity of the cash segment.

Part V

In conclusion, we believe that SEBI has misidentified the site of market failure. It is not (as is being incorrectly believed) that the options market has somehow failed by being too liquid, but that the cash market has failed by being too illiquid. Using the Kelkar-Shah framework, we show that the movement of prices—evidencing the existence of a dominant position and therefore market power—occurred in the cash markets.

The correct response to this phenomenon, in our opinion, would be to increase trading volumes in the cash market, instead of reducing trading volumes in the options market. To this end, we propose three specific policies: the rationalisation of transactions taxation, allowing cash settlement for futures, and relaxing eligibility norms for traded stock to be included in the derivatives markets. The advantage that these reforms have over rival proposals is that they do not call upon SEBI’s already-strained state capacity for their enforcement. They are, in one sense, “stroke of the pen” reforms in that they allow market participants to do something that they are currently barred from, instead of requiring the regulator to police market participants from not doing something. We end with warning SEBI in Oliver Cromwell’s immortal words: “I beseech you, in the bowels of Christ, think it possible you may be mistaken”.

Sumedh Gadham and Tarang Rathi are Third-Year law students at the National University of Juridical Sciences (NUJS), Kolkata. Their interests lie in legal theory, constitutional design, and regulatory law.