When Algorithms Bend The Index: The Jane Street Wake-Up Call

The recent case involving Jane Street Group’s alleged market manipulation exposes critical flaws in India’s current equity derivative markets and underscores the urgent need for comprehensive reforms. The firm's continued trading activities, despite warnings from regulatory authorities, highlight the inadequacy of existing market structures and surveillance mechanisms in detecting and preventing sophisticated manipulation tactics. This situation makes it clear that the entire market design and monitoring systems require a fundamental overhaul. Implementing advanced electronic surveillance, integrated position monitoring, and stricter oversight is essential to ensure that no market participant can exploit technological advantages to influence indices like Nifty and Bank Nifty for disproportionate gains. Reframing market design will be vital to protecting retail investors, maintaining market integrity, and restoring confidence in the financial ecosystem.

Regulators must integrate market oversight across India’s cash and derivatives trading. Currently, firms can hide their complete footprint using multiple broker IDs or subsidiaries. A smarter approach would connect related accounts, treating them as a single entity, similar to how commodity exchanges link trading IDs to owners or how the equities market could consolidate trade data. For instance, if one firm controls multiple stock and futures accounts, the system should flag when combined trades influence an index. While SEBI has tightened rules—such as measuring options on a “future-equivalent” basis—more real-time, cross-market surveillance is essential. Automated alerts should detect abnormal trading volumes, especially near expiry, and prompt regulator intervention. Widespread electronic linking and continuous monitoring, similar to the CFTC’s oversight of large futures traders, are crucial for exposing manipulative algorithms.

Borrowing from the Commodities Playbook

India’s agri-derivatives market enforces expiry discipline through differentiated position limits, which is worth examining. According to the regulatory norms, the near-month (expiry) contract is limited to just 25% of the total position, while participants in the far-month contracts can have a 100% limit. This structure recognises that the risk of price distortion peaks as expiry approaches, so position accumulation during this period must be limited.

On the cash side, if a participant’s intraday purchases in a single stock exceed a given share of its free float or daily trading volume (for example, 5–10%), exchanges should trigger automated alerts and warnings to participants. These measures are neither radical nor untested — they are standard in commodity markets to ensure orderly price discovery. Closing those gaps through calibrated position limits and expiry-day rules is both feasible and necessary.

Equity derivatives — particularly cash-settled index options would benefit from a similar safeguard. Implementing a lower position limit on expiry day, based on a delta-equivalent measure across options and futures, could directly reduce the incentive to manipulate final settlement prices. Alternatively, weekly index options, which inherently concentrate trading and settlement risk into a shorter period, could be assigned stricter, independent position caps — perhaps half or a quarter of what’s permitted for monthly contracts.

Rethinking Weekly Options: From Flexibility to Fragility

Weekly index options were meant to offer flexibility, but they’ve increasingly become fertile ground for expiry-day manipulation. SEBI has taken early steps to rein in these risks:

· Restricted weekly expiries to only Nifty 50 and Sensex; discontinued others

· Increased lot sizes, making each trade more capital-intensive

· Raised margin requirements on expiry days to deter leveraged play

These measures are fundamentally sound, but expiration-related distortions might remain unless additional structural tools are implemented.

· Impose significantly lower open interest limits during the final trading hour on expiry day, such as one-fourth of the usual cap.

· Establish tighter position limits specifically for weekly options contracts.

· Explore auction-based settlement mechanisms, such as call auctions or randomised closing windows, to prevent pinning at the expiry level.

· Revisit the use of VWAP for settlement pricing — replace/complement with alternatives like median pricing or segmented time-band averages, especially where stock concentration is high. The academic community must weigh in here.

If expiry becomes the primary focus instead of a genuine position ending, regulators need to shift their attention from trade volume to trade timing, structure, and incentives. Expiry shouldn’t be the point where markets are most vulnerable. It should be when they are most secure.

Global Best Practices

Across global markets, regulators have faced a common challenge: how to prevent single players from distorting prices in highly liquid contracts. When China launched the CSI 300 index futures, it initially limited positions to just 100 contracts to prevent any speculator from dominating a growing market. That limit was later raised to around 300 as volumes increased, showing that moderate restrictions can boost liquidity without enabling manipulation. In the U.S., the CFTC runs a 24/7 surveillance system that monitors large traders, price movements, and supply signals to identify potential manipulation in real-time.

India might adopt a different approach, but the core idea is clear: surveillance must be both data-driven and continuous. Exchanges can also help by using real-time heat maps that highlight unusual activity in a small group of index stocks, just as derivative volumes spike. Some markets can take it a step further, restricting order placement speed or adding micro-circuit filters to prevent sharp intraday price fluctuations. These are not futuristic but proven safeguards that, if incorporated into India’s tick-by-tick systems, could spot and prevent manipulation before it causes instability on any given day, whether it is the expiry or otherwise.

Toward Smarter Trading and Regulation

In today’s complex markets, trust is paramount. While the goal isn’t to punish speed or innovation, market participants should demonstrate adoption of self-imposed limits, similar to how high-frequency algorithms restrict position sizes or halt new orders if volatility exceeds certain bands. SEBI has taken positive steps, including increasing the lot size and enhancing vigilance on open positions. Still, as participant strategies become more opaque, regulations must shift from minor tweaks to comprehensive redesign that proactively addresses market behaviour. India can turn this challenge into an opportunity by tightening derivative access, setting cross-market limits, innovating close-price mechanisms, and enhancing surveillance, thereby making manipulation exceedingly difficult. The recent Jane Street episode underscores this need—markets are rule-based systems; if rules allow algorithmic strategies to easily manipulate indices, confidence will erode. The solution lies in the smart design of the markets/instruments, such as imposing costlier, more transparent manipulation barriers, and adopting surveillance practices from other exchanges. Preserving integrity requires collaboration among regulators, exchanges, and traders, ensuring manipulations are costly and detectable, thereby safeguarding trust and stability.

V Shunmugam is a seasoned financial markets expert with over two decades of experience in commodity and capital market policy, research, and development.