By Jayshree P Upadhyay

MUMBAI, July 9 (Reuters) - Jane Street has been barred

from the Indian securities market by its markets regulator,

which has said the U.S. firm used its trading strategies to

"manipulate" a key stock market index, leading to losses for

millions of retail investors, allegations Jane Street has

rejected.

WHAT EXACTLY IS SEBI ACCUSING JANE STREET OF DOING?

The Securities and Exchange Board of India (SEBI) in its

interim order said Jane Street accumulated large volumes of

constituent stocks of the Bank Nifty index, which

comprises the 12 top Indian bank stocks, in the cash and futures

markets, thus pushing up the index prices.

Simultaneously, Jane Street took short positions in the

derivatives segment by buying cheap "put" options and selling

expensive "call" options linked to the Bank Nifty, the regulator

said.

The SEBI order said that during the second half of most days

in which Jane Street's positions were studied, the U.S. firm

reversed the first leg of its trade, selling the constituents in

the cash and futures markets, thereby pushing down the price of

the index and its constituents.

This, in turn, led to a rise in value for the "put" options

and a drop in value for "call" options, earning Jane Street

large profits, which outweighed any losses that were incurred

during the first leg of the trade.

SEBI said this trading pattern created "a false or

misleading appearance of market activity" and attracted

"unsuspecting" investors to trade at levels that were

"artificial and temporary".

WHAT IS JANE STREET SAYING ABOUT ITS INDIA TRADING STRATEGY?

Jane Street, in an internal email to its employees, said the

activities in question were what is known as an "arbitrage

trade", which is commonly used by large trading firms in

financial markets.

In an arbitrage trade, firms simultaneously buy and sell the

same asset in different markets and pocket the profits from the

difference in prices.

In its internal memo, Jane Street argued there was a large

gap between the price of the Bank Nifty index in the options

markets and the price implied by the level at which the stocks

were trading. This divergence, it said, was clearly observed and

Jane Street traded in a direction consistent with closing that

gap.

Arbitrage trading is legal in India.

WHAT FACTORS WERE CRUCIAL TO JANE STREET'S INDIA STRATEGY?

According to details in the SEBI order, the first is size.

In the first leg of the trade, where Jane Street was buying

shares of constituents of the Bank Nifty Index, it was doing so

in volumes large enough to move the index.

Its trades made up 15%-25% of the entire market's traded

value in the constituents of the banking index, SEBI said.

The second is the distortions between the cash and

derivative markets in India.

India's derivatives-to-cash market ratio in terms of volume

is the highest in the world, SEBI said. In 2024, this ratio was

400 times.

In its order, SEBI highlighted Jane Street's trading

activities on January 17, 2024 - one of the trading days under

investigation - saying the U.S. firm traded roughly $1.2

trillion (103 trillion rupees) worth of cash-settled options on

the Nifty Bank index.

That amount equates to roughly 353 times the trading volumes

of the bank stocks in the index.

WHO ARE THE LOSERS IN INDIA'S DERIVATIVES MARKET?

Proprietary trading giants such as Jane Street have made

hefty profits from India's derivatives market, which accounts

for roughly 61% of equity options contracts that are currently

traded worldwide, according to data from the Futures Industry

Association.

In the 12 months to March 2024, proprietary traders and

foreign investors made gross profits of 330 billion rupees and

280 billion rupees, respectively, a SEBI study in September 2024

showed.

During that same period, retail traders lost 524 billion

rupees.

On Monday, SEBI said retail investor losses on derivative

trades widened by 41% to 1.06 trillion rupees in the subsequent

year. It did not blame proprietary traders for the widening

losses of retail investors and nor did it provide fresh data on

gains made by proprietary traders.

WHAT ARE THE NEXT STEPS FOR JANE STREET AND SEBI?

SEBI has seized $567 million of Jane Street's funds,

equivalent to the amount of what it calls "unlawful gains".

The U.S. firm can deposit that amount and regain access to

the Indian markets. It also has 21 days to file its reply or any

objections to the order, and can also challenge the order

judicially via the Securities Appellate Tribunal.

SEBI, meanwhile, is working on a final order and also

expanding its investigation into Jane Street's trade on indexes

other than the Bank Nifty.

(Reporting by Jayshree P. Upadhyay; Editing by Ira Dugal,

Anirban Sen and Muralikumar Anantharaman)