If You Have to Move the Market to Arbitrage, Maybe It’s Not Arbitrage
Why Jane Street’s “Index Arbitrage” Argument is Not Enough
On 3 July 2025, the SEBI issued an ex-parte interim order against Jane Street Group LLC, a US-based proprietary trading firm, alleging market manipulation of the Bank Nifty index by executing trades designed to distort the Bank Nifty index during intraday sessions, enabling the firm to benefit from its related options positions. The interim order directed Jane Street to: (i) refrain from accessing the Indian securities market, and (ii) deposit Rs. 4,843.57 Crores or $570 million of alleged unlawful gains in an interest escrow account. Jane Street has complied with the escrow directive and deposited the full amount. Subsequently, on 21 July 2025, SEBI passed a modification order, lifting the trading ban but with conditions on trading strategies.
Two things to be noted: First, the Order primarily addresses trades made only on 17 January 2024, when Jane Street earned nearly $85 million, despite the strategy reportedly being used for four years to generate almost $4 billion where $2.92 billion were via Jane Street Singapore and $789.39 million via Jane Street Asia Trading in Hong Kong. Second, given that the alleged unlawful gains total around $570 million (through JS-1 and JS-2 - Indian subsidiaries alone), SEBI has chosen to remain silent on the other days to preserve an informational advantage in the upcoming proceedings (probably).
But, let us look at the mechanics of the trade strategy. In the Intra-Day strategy, Jane Street aggressively bought large quantities of key banking stocks in the morning, which pushed the Bank Nifty index price higher.
At the same time, Jane Street has significant short positions in the index options, betting on a market decline. In the afternoon, the firm would aggressively sell off the stocks it had purchased, causing the index to fall. This drop would make its large options positions highly profitable, offsetting any losses from the stock sales and resulting in substantial net gains. Jane Street also combined this with “marking the close” by placing large orders near the market close, usually in the final hour to influence the closing price.
The intra-day strategy worked like this: assume Jane Street holds a large long position in Bank Nifty 47,500 Call Options, trading at Rs. 50 per lot on expiry day. At 3:15 PM, the index is at 47,420, below the strike price, rendering the option out-of-the-money. Jane Street then places large buy orders in underlying stocks of BankNifty Index such as HDFC Bank, ICICI Bank, SBI. etc. This pushes the index up by 100 points to 47,520 and the call option turns in-the-money, and its premium rises sharply from Rs. 50 to Rs. 140 due to delta sensitivity and expiry proximity. Holding 10,000 lots (15 units each), Jane Street realizes a gain of Rs. 13.5 crore on the options leg. It then exits the stock positions with relatively minor losses, with a net profit in total.
According to SEBI, the ‘intra-day market manipulation’ strategy combined with ‘marking the close’ strategy violated Regulations 3 and Regulation 4 of the SEBI PFUTP Regulations, 2003.
Jane Street is preparing its legal defense and has denied any wrongdoing and has asserted that its trades were legitimate index arbitrage. Most damning of these arguments in favour of Jane Street has come from financial commentators, who have questioned the perspective of SEBI’s findings, suggesting the trades reflect lawful and rather ‘basic index arbitrage’ strategy and not market manipulation.
A simplification of the argument is as follows: The lines between doing a legitimate arbitrage trade and market manipulation is rather blurry. In both scenarios, you are trading the opposite way, buying stock in the equity market and selling it in the options market or vice versa. However, if trade were legitimate arbitrage, that would have the tendency to make markets more efficient i.e. it will reduce the prices that retail investors were paying for options. However, if it was market manipulation, that would have the tendency to make markets less efficient, to make options more expensive for the retail investors.
In SEBI’s own chosen example, Jane Street was making markets more efficient and benefiting, rather than harming, retail traders. Instead of paying a 1.6% premium to trade the same underlying stocks in the options market, retail investors could pay a zero-ish premium; Jane Street pushed the options prices down and raised the stock prices and closed the arbitrage.
The above reasoning was by Matt Levine who also added that Indian options were so popular, and so hard to arbitrage, that Jane Street could make billions of dollars just moving them to their correct prices. That story should be annoying to SEBI too, even if it’s not Jane Street’s fault.”
But, such reasoning is simply insufficient to legitimize Jane Street’s trade strategy within the context of SEBI regulations. The analysis is in two parts: Firstly, assessing the technical aspects of the trades to question the legitimacy of the index-arbitrage strategy; Secondly, reviewing past SEBI precedents to determine whether the thresholds for market manipulation were met in this case or not.
On the first limb of the analysis, the legitimacy of Jane Street’s so-called index-arbitrage strategy is itself doubtful, and this section presents some reasons that cast doubt on Jane Street’s strategy.
A unique aspect of India’s financial markets is that the equity market is relatively small and illiquid, while the derivatives market is extremely large and highly liquid (sometimes 300 times bigger). Jane Street’s strategy took advantage of this imbalance between the two linked markets but what stands out is that trades in the smaller market consistently lose money, while positions in the larger market generate significant profits.
This raises an important question: if the profits come from the larger market, why trade in the smaller one at all, especially when (i) those trades regularly lose money, and (ii) they don’t seem to offer meaningful hedging in the Indian context?
The answer lies in the purpose of the trades. In a normal index arbitrage, each side of the trade exists to offset risks (hedge) and capture natural mispricings, which eventually disappear as the market corrects. In Jane Street’s case, the smaller market wasn’t used for hedging or correcting mispricings, it was a lever to move prices. Heavy trading in the equities markets was used to shift prices in the derivatives market and rake in net profit.
Jane Street is probably going to defend its heavy trades by saying that the market was inefficient and as market makers, we simply provided liquidity to fix it.
In reality, by deploying heavy capital in the illiquid equities market, Jane Street could deliberately move prices to benefit its derivatives positions. The equities positions were later closed at a loss, but the gains from derivatives were more than compensatory. To an outside observer, this looks like straightforward arbitrage: prices of same assets that were out of line have essentially converged and the both markets look efficient again.
However, this is the caveat: the convergence happened, and at that specific level, only because Jane Street wanted it at that specific level, and deliberately pushed prices there through heavy trading in the equities segment. Otherwise, they would not have converged in that way at all. In other words, the arbitrage did not collapse and the convergence point wasn’t discovered (like in normal arbitrage); it was manufactured by Jane Street to profit its position in derivatives segments.
Jane Street effectively set an artificial or false price level, which is not indicative of true supply and demand.
One proposed way to test if Jane Street’s strategy is genuine arbitrage or relies on market impact is to scale it down. True arbitrage often works proportionally better at smaller sizes because it creates less market impact. If Jane Street’s strategy fails when scaled down, the profits depend on its size, meaning gains come from moving the market, not from correcting the mispricings and pocketing the spreads. Simply put, in normal arbitrage, traders avoid moving the market or creating an impact because it reduces their profit margin. But for Jane Street, market impact is the source of profit.
Now, coming to second limb of the analysis, it becomes clear why the law may stand against Jane Street. Both the Supreme Court and the SAT had earlier held that mens rea (intent) is not essential for liability under the PFUTP Regulations.
However, the law has since evolved. In SEBI v. Rakhi Trading (P) Ltd. (2018), the Supreme Court described market manipulation as “a deliberate attempt to interfere with the free and fair operation of the market,” but penalized the traders, engaged in synchronized trading, without requiring proof of actual market impact, holding that the deliberate and manipulative conduct itself was sufficient.
As the law stands today, Rakhi Trading is the governing precedent, and it does require mens rea to be shown i.e., a deliberate attempt to interfere with the free and fair operation of the market. However, as SEBI proceedings are civil where, intent need not be proven beyond a reasonable doubt, but on preponderance of probabilities standard, meaning it is more likely that misconduct occurred.
Although Rakhi Trading dealt with synchronized trading, the Court’s observations also sheds light on how Jane Street’s strategy might be interpreted:
“…Contextually and in simple words, it [unfair trade practices] means a practice which does not conform to the fair and transparent principles of trades in the stock market… Nobody intentionally trades for loss. An intentional trading for loss per se, is not a genuine dealing in securities. The platform of the stock exchange has been used for a non-genuine trade. Trading is always with the aim to make profits. But if one party consistently makes loss [sic] and that too in preplanned and rapid reverse trades, it is not genuine; it is an unfair trade practice…”
The reasoning in Rakhi Trading resonates directly with the intra-day strategy, whereby Jane Street’s trades in equities consistently lost money, while its derivatives positions generated large gains consistently. If the equity trades were not hedges and offered no meaningful independent profit opportunity, their purpose cannot be genuine market activity as “nobody intentionally trades for loss”. The supposed closing of arbitrage was in fact manufactured convergence: heavy equity trades were used to move prices in favor of Jane Street’s larger derivatives positions. These loss-making equity trades were not incidental but deliberate and instrumental. Under Rakhi Trading, such strategies qualify not as genuine arbitrage but as unfair trade practices.
Simply put, SEBI’s case will be easier to prove. First, the line of reasoning Jane Street might advance is not bulletproof as shown in the first limb of analysis. Second, the preponderance of probabilities threshold of such proceedings is not hard to clear for SEBI considering the above analysis. Third, this is combined with SEBI’s allegation that Jane Street had been warned about its strategy but continued regardless (with some changes), which shows deliberate misconduct.
As of now, Jane Street has sought to portray their trades as a ‘basic index arbitrage’. However, the use of heavy-handed deliberate loss-making equity trades to move prices for gains in countering derivative positions suggests manufactured convergence, not genuine arbitrage. As per Rakhi Trading, where “nobody intentionally trades for loss,” this appears more like an unfair trade practice rather than market-making. Additionally, SEBI’s preponderance of probabilities threshold and claims that Jane Street ignored warnings furthers its case.
Post SEBI’s modification order lifting the trading ban, Jane Street had asked for extension in filing their replies. However, on 2nd September Jane Street decided to file an appeal against the order with SAT on ancillary grounds, rather than on the merits of the case. However, one thing is clear: Jane Street’s tussle with SEBI will be a critical test of how SEBI and courts draw the line between heavy trading strategies and manipulative market practices.
P.S.: Shreedhar Manek from Boring Money wrote a really good piece breaking down Jane Street’s “completely-innocent index arbitrage” trade strategy. Highly recommend giving it a read, he explains it way better than I could have.