Why margin trading on ETFs is a strategic shift

India’s stock market has been on a wild ride of innovation lately, and one of the most interesting developments that might have flown under your radar is the introduction of margin trading on exchange traded funds (ETFs) back in December 2022.

At first glance, it might have seemed like just another regulatory tweak, but it actually is a pretty big deal. It’s fundamentally changing how investors like you can get broad market exposure while making your capital work harder.

From zero to hero

Think about it: For almost 20 years, ETFs in India were pretty much limited to a simple “buy and hold” strategy. They lacked the leverage options you see in more developed markets. Basically, they were passive investment vehicles, which meant you couldn’t really use them for tactical trading or more sophisticated portfolio moves.

Then, in November 2022, the Securities and Exchange Board of India (Sebi) dropped a game-changing circular, which went live on December 29, 2022. This wasn’t a spur-of-the-moment decision; it came after a lot of discussion by the Secondary Market Advisory Committee. The goal? To bring India in line with global best practices and allow certain highly liquid and stable equity ETFs (dubbed “Group I”) to be traded on margin. This opened a whole new world for Indian investors.

The growth story

The ETF market in India has exploded, according to data from the Association of Mutual Funds in India (AMFI). As of June 2025, assets under management (AUM) in ETFs have soared to approximately Rs. 9.24 trillion, a fourfold increase from approximately Rs. 1.86 trillion in June 2020. That’s huge! But even with all that growth, ETFs were missing a key ingredient: the dynamic trading that margin facilities can unlock. This is especially true for active traders and bigger institutional players. Now, with margin trading in the mix, we’re looking at potentially increased liquidity and a lot more flexibility.

The regulatory angle

Now, before you get too excited and start thinking about turbocharging your portfolio, it’s important to know that this isn’t a free-for-all. The margin trading framework is designed with some pretty solid safety nets. Only the most liquid and stable ETFs (remember, Group I) are eligible, which means leverage is being extended carefully. The margin requirements are set at VaR (Value at Risk) plus three times the applicable Extreme Loss Margin (ELM) for Group I stocks available for trading in the F&O segment, and VaR + 5 times applicable ELM Group I stocks other than F&O stocks and units of Equity ETFs (applicable VaR and ELM shall be as in the cash segment for a particular stock). It’s a conservative approach that tries to strike a balance between risk and opportunity.

But, here’s a cool bonus: ETFs can now be both traded on margin and used as collateral. This gives both retail and institutional investors a lot more flexibility in how they manage their portfolios.

The ups and downs

It’s been nearly three years since this all started, and we’re seeing some encouraging progress.  But let’s be real, it’s not all sunshine and rainbows. One of the biggest challenges is liquidity. The bid-ask spreads (the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept) can average around 17 basis points for even the largest ETFs. This can make leveraged strategies less attractive. Also, the operational infrastructure, especially the auto-pledging and collateral management systems, have only recently matured. We’ve seen some major upgrades as recently as February 2025, and these improvements are crucial for making ETF margin trading accessible and user-friendly for everyone.

The big picture

The introduction of ETF margin trading shows that India is serious about making its market more sophisticated. In developed markets, leverage on ETFs has been a game-changer, boosting liquidity, tightening spreads, and making complex strategies possible.

For institutional investors, margin-enabled ETFs make it easier to adjust asset allocation without the hassle of building individual stock positions. For retail investors, they offer a diversified way to use leverage, which can reduce the risks of concentrating on single stocks while still enjoying the benefits of leverage.

With so many new demat accounts (over 20 crore as per recent data) and the growing popularity of systematic investment plans (SIPs), offering structured leverage through ETFs aligns perfectly with the trend of Indians investing more in the financial markets.

What’s next? 

Sebi is already reviewing the margin trading framework (they announced this in August 2025), which shows they’re committed to making it even better. As we gain more experience, we expect to see refinements in the eligibility criteria and risk management measures.

The market is also showing strong growth. The margin trading segment has jumped from Rs. 50,000 crores in March 2024 to peaks of Rs. 96,000 crore, which tells us that investors are definitely interested. As ETF liquidity improves and the infrastructure gets even stronger, margin trading on ETFs is set to become a major part of leveraged investing in India.

The bottom line

The journey from regulatory approval to widespread adoption is going to take time, but the future looks promising. The liquidity issues and operational hurdles are temporary and should fade as the market matures.

For investors, the key is to use leverage wisely. Remember that ETFs offer diversification, but leverage always comes with risks that you need to manage carefully. The real advantage here is the ability to diversify your leveraged positions, and that’s a powerful tool in the right hands.

(The writer is MD & CEO of HDFC Securities)