SEBI has increased the tail-risk coverage by imposing an additional ELM (Extreme Loss Margin) of 2 per cent for short-options contracts
A series of measures introduced by the Securities and Exchange Board of India (SEBI) to strengthen the index derivatives framework will go live on November 21, 2024. This move is aimed to protect small investors and enhance market stability. As these new rules roll out, traders - particularly retail participants - will see notable changes in the equity derivatives landscape.
SEBI’s new rules include six major adjustments to the Index Derivative Contracts framework. These changes include a reduction in weekly expiries, increased contract sizes, higher margin requirements, upfront collection of premiums, removal of calendar spread benefits, and stricter intraday monitoring of position limits.
However, only three of these clauses will take effect from tomorrow, November 21, 2024. These include recalibration of contract sizes, the rationalization of weekly index derivatives, and an increase in tail risk coverage on expiry days. While the other three changes will be phased in from December 1, 2024, to April 30, 2025, these initial adjustments are significant.
From November 21, 2024, both the National Stock Exchange (NSE) and BSE will limit weekly expiry contracts to a single benchmark index. Only Nifty 50 and Sensex will retain their weekly expiry contracts, while six other index derivatives will no longer have weekly expiry options.
Secondly, index derivative contract sizes will increase from Rs 5-10 lakh to Rs 15 lakh. The NSE Nifty 50 lot size will increase threefold from 25 to 75, and the BSE Sensex lot size will double from 10 to 20. Nifty Bank and BSE Bankex lot sizes will rise by 2x to 30. These changes are likely to make the F&O market more accessible only to those with significant capital and a higher risk appetite.
In another key measure, the markets regulator has increased the tail-risk coverage by imposing an additional ELM (Extreme Loss Margin) of 2 per cent for short-options contracts. This intends to limit the heightened speculative activity around options positions and the attendant risks on the day of options contracts expiry. ELM is the additional margin that exchanges charge over and above the normal margin requirement. Tail-risk refers to the chance of a loss occurring due to a rare event.
How the 2% Margin Increase on Options Contracts Will Affect Traders
Starting tomorrow, the change in tail risk coverage will result in higher margin requirements for all index derivative contracts that expire on the same day. The ELM margin will rise from 2 per cent to 4 per cent, which means the overall margin requirement will increase from approximately 11 per cent to 13 per cent.
According to experts, the requirement for higher tail-risk coverage on expiry days is expected to increase margin requirements, impacting traders with aggressive positions.
For traders with short positions in Nifty's November 21 expiry contracts, this means they may need to add extra margin to their accounts, especially if they haven’t already accounted for the additional buffer. This will apply to Sensex on November 22 and for subsequent expiries as well.
Ashish Nanda, President and Head of Digital Business at Kotak Securities, explains the impact of the new 2 per cent margin increase on Index Derivative contracts, “let’s break down the numbers to get a better idea. If the Nifty is trading at 24,000 and the lot size is 25, the total contract value is Rs 6,00,000. Under the new regime, the margin, which was 12 per cent of the contract value, would have been Rs 72,000. With the 2 per cent increase in margin, this rises by Rs 12,000, bringing the total margin requirement to Rs 84,000 – a 16-17 per cent increase”.
While the 2 per cent increase may seem small, it can lead to significant shortfalls for many traders. This is because, under the previous system, margin requirements would decrease for out-of-the-money (OTM) strikes. For example, an OTM strike with a margin of Rs 37,000 would increase by Rs 13,000 to Rs 50,000, which is a 35 per cent jump.
On the other hand, “for in-the-money (ITM) options, the margin increase would be less than 16-17 per cent. The key point here is that the margin increase applies directly to the contract value, with no relief from hedging benefits. This could have a significant impact, especially for those who rely on hedging strategies,” he added.
“This could reduce extreme volatility around expiry, which has historically accounted for sharp price movements. For context, peak-day losses in retail accounts during expiry sessions have exceeded Rs 1,000 crore in certain months,” said Puneet Sharma, chief executive officer (CEO) and fund manager at alternative investment fund Whitespace Alpha.
The increase in tail risk coverage is a key step toward strengthening market stability by requiring higher margins on expiry days. While the rise in margin requirements may seem minor, it will have a significant impact on traders, especially those with short positions. As the market adjusts to these changes, the full impact will become clearer in the coming days, pushing traders to ensure they are well-prepared to meet the higher margin demands.