Two major quantitative titans on Wall Street are in a legal battle, inadvertently providing an opportunity for the outside world to "peek" into how top Wall Street hedge funds use options to "quietly reap profits" in the Indian market.

In April of this year, the world's top quantitative firm, Jane Street Group, went to court against Millennium Management.

According to the lawsuit documents, Jane Street Group accused two former employees who defected to Millennium Management of stealing highly confidential and "extremely valuable" Indian market trading strategies. Jane Street Group stated that after the two traders switched companies, the company's profits from using the strategy in a single month dropped by 50%, which could only be explained by their main competitor also using the same strategy.

After several rounds of court battles, the case has recently made significant progress. On October 9th local time, the New York District Court ordered Jane Street Group to provide a detailed explanation of how it calculates the compensation for lost profits by October 29th.

It is believed that as one of the most secretive companies on Wall Street, the latest court order may force Jane Street Group to disclose more financial information, revealing to the outside world how the company's options team "makes a killing" in the Indian market.

Advertisement

The "counterintuitive" money-making strategy

According to the lawsuit documents in April, the core focus of this lawsuit centers on two former Jane Street Group employees, Douglas Schadewald and Daniel Spottiswood.

Jane Street Group stated in the lawsuit documents that the two employees stole a "highly valuable, unique, and proprietary" Indian market options trading strategy. "By identifying certain signals, strategies, and methods of analyzing and interpreting these signals, the company can reliably predict future market activities."

Jane Street Group stated that the initial research results and the scale of potential opportunities for the strategy were "counterintuitive" and faced serious skepticism within the company. However, subsequent research found that if the trading concept could be further developed and applied, there would be a huge potential opportunity.During the period from 2018 to 2022, the preliminary research, experimentation, and development process of the trading strategy brought "insignificant" profits to Jane Street Capital. However, by 2023-2024, the strategy had become "fully mature." The profitability of the strategy experienced an explosive growth in the second half of 2023, "multiplying several times" compared to the first half of the year, and the overall strategy maintained this level of profitability in January and February of 2024.

Although Jane Street Capital redacted the relevant profit data in the court documents, according to the information disclosed during the trial, the company made about $1 billion from the strategy in 2023.

With the departure of two traders in February 2024, Jane Street Capital immediately noticed a sharp decline in the strategy's returns, with profits in March dropping by 50%. Based on feedback from brokers, the company believes that this situation can only be attributed to "the emergence of another competitor in the market using the same strategy."

Jane Street Capital is asking the court to order Millennium Management and the two traders to immediately stop using the strategy and to compensate for the "stolen strategy."

Millennium Management, on the other hand, argues that the two traders established Jane Street Capital's Indian options business, but the trading was based on experience and expertise, not "algorithms or automated signals." Moreover, Jane Street Capital's income statement (still under seal) shows that after the two traders left, the company's Indian options trading performance reached a new high in April, and this momentum continued for the next two months.

Millennium Management likens these two traders to gold miners who "truly know how to use a pickaxe," stating that they use basic options trading strategies that have long been discussed in textbooks and articles. They "absolutely deny" using any data obtained from their former employer.

There is no secret; they can make guesses and take risks based on their experience in finding differences between stocks and options, and they are willing to bet.

It is worth noting that one of the two traders, Doug Schadewald, was already famous before joining Jane Street Capital. He had been included in the Forbes 30 Under 30 list and had become a star trader while managing the S&P 500 and VIX derivatives portfolio at Barclays. During the February 2018 U.S. stock market volatility crisis, Schadewald and his trading team reportedly brought huge profits to Barclays, and he joined Jane Street Capital later that year.Wall Street "Gold Rush" in India

Due to suspected trade secrets, many court documents in the case have been sealed or deleted. The litigants also made every effort to avoid revealing any detailed information during the trial. However, the fact that the strategy involved Indian options trading was inadvertently disclosed at a court hearing shortly after the case was filed.

Although the specific details of the options strategy have not been disclosed, according to Bloomberg, many Wall Street trading firms have adopted a relatively simple strategy in the Indian options market: shorting volatility.

This trade or similar trades revolve around betting that the Indian stock index will fluctuate within a relatively small range. High-frequency traders sell options, while long funds and retail investors buy contracts for speculation or to protect themselves from the impact of sudden market declines.

This bet is obviously profitable: Bloomberg data shows that in the past 500 trading days (up to May of this year), the Indian stock market benchmark index only rose by 2% or more on 9 trading days.

However, the potential risks of the strategy cannot be ignored: if the market experiences a sudden significant fluctuation, companies will face huge losses.

In the United States, such trades led to the "Volatility Apocalypse" in February 2018. At that time, a large number of investors using low volatility strategies (shorting volatility) suddenly encountered a sudden surge after years of calm: the VIX index suddenly soared from a relatively low level (about 13-17) at the beginning of February, and once reached 37.32 on February 5th, with an increase of nearly 115%, which was one of the largest single-day increases in the VIX index in history. A large number of VIX short sellers "lost everything" overnight.

In addition to shorting volatility, Wall Street high-frequency trading firms also profit from a series of options buying and selling, making profits from the Indian options market through the bid-ask spread.Wall Street Hedge Funds "Mowing Down" in India

According to data from the Futures Industry Association (FIA), last year India accounted for 84% of all global stock options contract transactions, up from just 15% a decade ago. The contract trading volume for 2023 reached 85 billion, and has been doubling annually since 2020.

Derivatives market trading volumes are also surging rapidly: since 2019, the trading volume of India's derivatives market has skyrocketed by more than 40 times, reaching a record $6 trillion in February this year, surpassing the size of India's economy.

Multiple factors have contributed to the "boom" in India's derivatives market: the short-term contracts introduced by exchanges in 2019 (weekly expirations replacing traditional end-of-month expirations) have stimulated trading volumes; various trading apps are widely popular, with influencers flaunting luxury cars and mansions online to promote trading courses; and retail investors are dreaming of "betting big to become Ambani" (the richest man in India).

Video Title: How to Invest with Only 1000 Indian Rupees (84 RMB)

In India's low-value, high-volume market, Wall Street hedge funds and high-frequency trading firms are "dominating". In addition to Jane Street Capital, well-known hedge funds including Optiver and Citadel Securities have also started operations in India.

A study by India's market regulatory authority shows that last year, foreign funds and proprietary trading departments made a profit of 588.4 billion rupees ($7 billion) from Indian stock derivatives trading.

However, most of the profits of Wall Street hedge funds come at the expense of losses for individual retail traders in India: in the fiscal year ending in March, they lost a total of 610 billion rupees in stock futures and options.

Research by the Securities and Exchange Board of India (SEBI) shows that 9 out of 10 retail derivatives traders are losing money, with an average loss of about 200,000 rupees per trader. Only 1% of traders made a profit of more than 100,000 rupees. Among India's 10 million individual traders, over 75% have an annual income of less than 500,000 rupees (42,000 RMB).