SEBI, Jane Street, And The Arbitrageur’s Edge

SEBI’s interim order against Jane Street has found easy public sympathy, painting the regulator as the champion of retail traders—the underdogs in India’s complex derivatives market. But while that storyline has appeal, the reality is far less black and white. For those willing to look past the populism and dive deep into the 105-page interim order, this case raises a more nuanced question: what exactly did Jane Street do wrong?

The answer, based on SEBI’s interim findings, is anything but straightforward. 

On  January 17, 2024, Jane Street executed a series of trades in Bank Nifty constituents and its futures and options. According to SEBI, these trades occurred in two patches: the morning (Patch I), when the firm built positions, and the afternoon (Patch II), when it unwound them. The trades netted Jane Street significant profits, which the regulator argues came at the expense of retail participants who were on the other side.
 
What precisely is Jane Street accused of doing? In the morning, it aggressively bought Bank Nifty and its constituent stocks, pushing prices up. At the same time, it sold calls and bought puts on the Bank Nifty in volumes that appeared excessive relative to the delta of the underlying positions, effectively establishing a short via options while going long on the underlying. By afternoon, it began selling off what it had bought in the morning, allegedly doing so in a way that pushed prices down. Its short positions via options therefore resulted in large gains.
 
To SEBI, this pattern suggests market manipulation. But to anyone familiar with expiry-day options trading, it reads more like a large arbitrage strategy executed in a market unused to that kind of size.
 
Expiry Mechanics
Expiry days are not like normal trading sessions. The options market becomes especially sensitive, with at-the-money contracts displaying enormous ‘gamma’—a measure of how quickly an option’s delta changes with price. Gamma is highest near expiry, and highest still for ATM options. This creates a situation where the hedge ratio must be adjusted constantly, a task suited only to sophisticated players.

Another risk, less well known outside trading desks, is 'charm,' which reflects the time decay of delta. It means the delta of an options portfolio doesn’t just move with the underlying price, but also with the passage of time. This is particularly acute on expiry day, when most options lose delta quickly.
 
Near ATM options are the only viable instruments for arbitrageurs to trade at scale on expiry day as their liquidity makes alternatives impractical. SEBI’s report goes into some depth on delta mismatches but appears to omit considerations like gamma and charm. On a normal day, that might be excusable. On expiry, it leaves a significant hole. Without accounting for these dynamics, it is simplistic to assume Jane Street’s hedge ratios were inexplicably large.
  
What made Jane Street act? The report itself notes that options were mispriced: puts were undervalued, calls overpriced. In such a situation, a textbook arbitrage strategy is a risk reversal: buy the puts (the undervalued security), sell the calls (the overvalued security), and delta-hedge via a long position in the underlying. 
 
Jane Street seems to have done exactly that. SEBI takes issue with the size of the options leg, implying that it dwarfed the underlying exposure. But as explained earlier, expiry dynamics justify this. Hedging needs to account for the changing delta over the trading day. A portfolio delta that looks mismatched in the morning could be entirely justified by 3 pm.
 
Aggressive Trading
SEBI also flags Jane Street’s “aggressive” execution style—lifting offers in the morning, hitting bids in the afternoon. But speed is essential in arbitrage. To capture it, all legs of the trade must be executed near simultaneously. Waiting for limit orders to be filled is not a luxury arbitrageurs can afford.
 
In Patch I, Jane Street bought aggressively because it needed to build its delta hedge. In Patch II, it sold aggressively because it needed to unwind its hedge exposure before options expiry. The trades were large, and their market impact was real. But that’s a function of size.
   
One of SEBI’s more surprising conclusions is that the late afternoon selling lacked “economic rationale”. But from the perspective of an arbitrageur, the rationale is risk management. The firm was holding long futures and cash equities, that hedged the short via options that were about to expire. If it held onto the long positions, the options would vanish with expiry, leaving it with an unhedged directional risk overnight.
 
Liquidating those positions, even at a loss, is standard risk management. That those liquidations contributed to a drop in prices is incidental. They were in theory not designed to manipulate the market, but to neutralise exposure. That it incurred a loss on the delta hedges is incidental to overall profitability. Delta hedge profits or losses cannot be viewed in isolation—a fundamental tenet of hedge accounting.
  
Secondly, the time value of options decays to zero on expiry. ATM options have the highest time value. Option sellers typically focus on capturing this time value, which is why ATM and near-ATM options are the most liquid on expiration day. There is little interest in trading OTM options from sellers on expiry unless they are severely mispriced.
 
Which is why it’s unclear why SEBI has chosen to highlight Jane Street’s use of ATM options in its report—anyone looking to profit from the kind of mispricing described had little real choice. On expiry, options are effectively what are known as ZDTEs—zero days to expiry option contracts. These come into existence in the morning of a trading day and expire by the evening, and trade in large volumes across international markets. The risks involved with ZDTEs have also been linked to increased intraday volatility in underlying indices—much like what’s seen in India on expiration days, where the options functionally behave as ZDTEs.
 
A recent academic study in US markets found that the median option maturity for retail traders is one day, the median holding period is just half an hour, and most trades are concentrated in ATM options. This suggests that retail traders internationally, much like their Indian counterparts, are also focused almost entirely on ATM ZDTEs.
 
Regulatory Lag 
The real story here may not be market abuse, but regulatory lag. Jane Street’s actions did not appear to violate position limits. Yet, they unsettled the market. That suggests the limits themselves are ill-defined. SEBI has already moved to calculate exposure by a single participant on a delta-equivalent basis, rather than by number or face value of contracts, making it more reflective of true risk. But the effectiveness of this will depend on how frequently positions are monitored and the models used to calculate exposure.

If limits are enforced only at day-end, for instance, there’s still room for intraday build-up and unwind of large trades—exactly what Jane Street did. To really regulate market impact, exposure thresholds need to be enforced throughout the day.
  
It’s also worth asking why these mispricings exist in the first place. Much of it has to do with the rise of retail participation in short-term options. Studies from US markets show that retail traders favour ultra-short-dated ATM options and hold them for under 30 minutes. India appears to show similar behaviour. Weekly expiries and high leverage have made ZDTEs wildly popular.
 
When large groups of retail traders trade directionally in options, they create distortions. Arbitrageurs like Jane Street move in to correct them—profitably. This is not manipulation, but a predictable consequence of fragmented, retail-heavy order flow.
   
Another underappreciated issue is the risk ZDTE options pose to the system. Their high gamma means they generate large intraday flows. As options near expiry, their sensitivity to price movement increases dramatically, often leading to whipsaw moves in the underlying index via delta hedging.
 
Jane Street’s trading may have amplified volatility on January 17, but so did the broader structure of the market. In effect, India has created a playground for intraday speculation through ZDTEs. SEBI’s move to reduce the number of weekly expiries is a welcome step. Other ideas include higher margins on ultra-short-dated options, restricting trading hours, changing the timings of derivative markets on expiry days, or using alternate methods to calculate settlement prices that reduce last-minute distortions. In some international markets, retail traders are disallowed from naked option selling without proof of expertise. Perhaps something similar is worth exploring.

Question of Scale
At its heart, this case is about scale. Jane Street trades in volumes that make sense in US markets, but overwhelm India’s relatively incomplete ones. The profits made may be legal, but they trigger discomfort when they come at the expense of thousands of retail traders by moving markets by their impact.
 
This is not unique to India. Central banks intervene in currency markets precisely because large flows can have disproportionate effects. Large players change price, not by intent but by sheer weight. Jane Street, in that sense, is no different. The question is whether India’s markets are ready for such players.
 
If not, the answer lies in better rules. Not retrospective charges.
  
If the aim is to protect retail traders without market efficiency grinding to a halt, the answer isn’t to look back in anger. It’s to draw clearer lines going forward. That means tightening delta-based position limits, improving real-time surveillance, and being selective about access to ultra-short-dated options. But it also means accepting an uncomfortable truth: arbitrage isn’t the enemy. It often keeps mispriced markets from completely unravelling.
 
Jane Street may not be entirely blameless. There may well be technical violations, especially around FII intraday share trading rules. If so, they should be penalised accordingly. But the bulk of the trades appear to be strategies any large firm could execute, and have likely executed elsewhere.
 
Rather than debating whether a hazy line was crossed, it may be wiser to draw the boundary more clearly. For both traders and regulators, fairness lies not in hindsight, but in clear rule-making.
 
Note: This analysis is based on publicly available data from SEBI’s interim order. If additional disclosures are made, the conclusions may require revision.

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