India has found itself caught in the crossfire between two American investment management giants—Jane Street Group and Millennium Management Global Investment.

On 12 April, Jane Street sued Millennium as well as former employees Douglas Schadewald and Daniel Spottiswood for stealing crucial intellectual property (IP) while defecting to the rival hedge fund. Jane Street argued that the stealth of this crucial and secret trade strategy—which included certain signals and techniques—squeezed its profits.

In March, Jane Street suffered a 50% drop in profits using this scheme, it said, attributing it to “the entrance of a competitor using the same strategy”.

The India context emerged in the hearings on Friday. Turns out the secretive trading strategy that Jane Street used to make big money—$1 billion last year—basically involved timing its investments in Indian short-term options trading. Sadly (or not), this strategy is no longer exclusive.

While this case largely pertains to two companies fighting over lucrative trade strategies and IP, the India angle is key.

The case: Apart from how much money it made, the significant role the options trading market plays in Jane Street’s “secret” strategy can be gauged from the fact that the firm wanted the hearing to be closed so that this “immensely valuable” information wouldn’t spill further. A Jane Street lawyer said the strategy, developed last year, was its most lucrative and the fear was that even identifying the country would lead to everyone “picking apart” the details.

It demanded an immediate restraining order barring Millennium from using this strategy.

While the judge in Manhattan hearing the case declined both, it urged the parties to avoid any information that explicitly mentions the trade secrets Jane Street is trying to protect.

So, how do we know it involves India? It inadvertently came up during the trial; the ex-employees believe it is really no secret and is just basic knowledge. Lawyers representing the traders and Millennium argued that tapping into options trading in India is no “secret sauce”. There are media reports that outline their lucrativeness and the government too has been promoting it, they argued. They said the traders were merely using a textbook strategy.

“It's one of the largest if not the largest options trading markets in the world,” said the attorney representing Millennium. The attorneys also said that other factors, including a decline in volatility, may have contributed to Jane Street’s profit drop.

The India angle: Now, it’s obvious that Jane Street wants to keep competitors like Millennium out because of just how big the opportunity in the Indian short-term options trading is. Business Insider cited attorneys representing Millennium and the traders as saying that Jane Street made $185 million in the period in question; and this is half of what Jane Street expected to make from India’s options trade. Multiply that by 12—pretty big sum there.

According to Business Insider, the firm, which trades with its own capital, began looking into India for options trade in 2018 and spent millions developing this strategy. The report added that it tried keeping its trade to avoid “sending signals to the rest of the market”.

The reason that India’s options market is seeing a lot of interest from giants like Jane Street is that derivatives trading has attracted a lot of attention, especially from retail investors. Going by a Wall Street Journal report, India accounted for 78% of equity options contracts traded worldwide in 2023.

“Derivatives function on the concept of leverage, which means your profits and losses are amplified. A higher expectation of exponential profit is making the Indian derivatives segment very attractive,” explains Sagun Agrawal, a financial analyst focused on derivatives trading and founder of Dhan Diksha, a startup promoting financial literacy. “The [Indian derivatives] market is very liquid and showing decent volatility, and both of these factors lead to more attractive options premiums.”

There are other reasons for the boom internationally as well. “The Indian capital market has outperformed other emerging markets,” says Agrawal, adding that the “China plus one” strategy adopted by the West has resulted in India attracting investments, which inevitably translates to a stock market boom.

However, even though everyone is flocking to this market, many are also losing money.

Here’s why. Options contracts are part of the derivatives market where contract holders have the right to buy or sell a security at a pre-set price at a future date but are not obliged to do so. So, it is highly speculative. Also, the boom currently being observed is for short-term trading. Here, time is of the essence, so executing a trade requires swift knowledge of the market and has to be done within seconds to win the game.

There are two reasons for this, which also explain why players like Jane Street are able to make big money here.

One, retail investors lack the knowledge that big institutional players have.

“Retail investors are largely untrained in the sophistication required in options trading. Since options trading is a zero-sum game, their loss is the profit of Wall Street giants that are run by highly trained and qualified professionals who are adept at options trading strategies and know how to manage the risks involved,” says Agrawal. A zero-sum game here means that either the buyer or seller of the options contract will make a profit—not both or neither. So, if Jane Street is profiting, someone else is losing big time.

The second reason is largely algorithmic trading. This allows algorithms to govern and execute large volumes of trades in less time by setting certain criteria.

“Algorithmic trading is based on historical data and trends. So black swan events [once-in-a-lifetime events like the COVID-19 pandemic] are uncharted territory for the algorithm. And the trading can go out of hand very quickly… So the risk factor of trading multiplies manifold,” Agrawal explains. While institutional investors and proprietary traders are in a better position to absorb this shock, the risk is massive for a retail investor.

Both retail and institutional investors use such trading, but the big guns have a greater edge. This is because they can execute trades faster, more efficiently and have been using it for years. In addition, their volume of trading can manipulate algorithms, creating an artificial demand and supply gap. Firms like Jane Street, for example, can outdo many individual investors by simply deploying more resources towards high-speed trading.

“Retailers are at a bigger disadvantage simply due to asymmetric information,” says Agrawal. “Retailers rely on brokers most of the time to recommend and execute their algo trading strategies—so they may find themselves incurring losses or reduced profits because of this lack of transparency and reliance on someone else. Institutions, on the other hand, have greater control; they have the power of volumes on their side and often that plays to their advantage.”

For more on algorithmic trading, read our story on Retail algo: The good, the bad and the ugly.

Jane Street is just one example. While much of its actual strategy remains unknown, it offers an insight into the ways in which global firms can easily profit off the exuberance in the Indian options segment.

(Photo from Unsplash)