Capital markets regulator Securities and Exchange Board of India (SEBI) has released a set of six guidelines to strengthen the equity index derivatives, also known as equity futures and options (F&O), framework.
The derivatives market has been witnessing a massive boom in trading volumes, with majority of investors facing losses. The increased activity in the F&O segment has become a serious concern for the government and regulators, as rising F&O volumes have started to affect the capital formation and pose a systemic risk to the country’s economic growth.
According to market analysts, tighter F& rules could enhance market stability and play a crucial role in safeguarding investor interests, ensuring a more resilient derivatives market.
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A recent SEBI study revealed that 93 per cent of individual F&O traders lost money in three years from FY22 to FY24. Only 7.2 per cent of individual F&O traders made a profit of which only one per cent of individual managed to earn profits exceeding Rs 1 lakh.
The regulator said it will start implementing a new framework in a graded manner beginning from November 20. The new rules are based on recommendations by an Expert Working Group (EWG) to strengthen the equity index derivatives framework
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Here are SEBI’s new rules for F&O segment and their implications on investors:
Upfront collection of option premium: According to SEBI, to avoid any undue intraday leverage to the end-client, and to discourage any practice of allowing any positions beyond the collateral at the end-client level, it has been decided to mandate collection of options premium upfront from options buyers by the Trading Members (TM)/ Clearing Member (CM). The new rule will be applicable for equity derivatives segment from February 01, 2025.
Prashanth Tapse, Sr VP Research – Research Analyst at Mehta Equities Ltd says steps to mandate the upfront collection of option premiums from buyers, along with other measures won’t change market direction but this can bring in informed players with calculated risk of trading and investing in markets.
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Removal of calendar spread treatment on the expiry day: Expiry day can see significant basis risk, where the value of a contract expiring on the day can move very differently from the value of similar contracts expiring in future. The regulator has decided that from February 1, 2025, the benefit of offsetting positions across different expiries shall not be available on the day of expiry for the contracts expiring on that day.
Kumar Sanghvi, chief strategy and transformation officer at HDFC Securities says withdrawing cross margin benefit for calendar contracts on the last day, will force players to do rollovers early and not wait till expiry day, easing expiry day “basis” speculation.
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“Basis is the difference between futures price and stock price which gets extensively impacted during rollovers eventually impacting underlying asset price leading to undesired movement in prices of all derivatives instruments of respective underlying asset,” Sanghvi said.
About 98 per cent contracts in derivatives are in options segment having index as underlying and therefore restrictions are rightly applied only to index derivatives and not to stock derivatives. Index option contracts at 6484 crores in current fiscal 6 months has already reached two third of last whole year 12 month number of contracts which was 9365 crores and is growing at exponential pace year-on-year demonstrating high participation especially of retail as well which is a concern.
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Contract size for index derivatives: SEBI has increased the minimum contract size for index futures and options from Rs 5-10 lakh currently to Rs 15 lakh at the time of its introduction in the market. Additionally, the lot size shall be fixed in such a manner that the contract value of the derivative on the day of review is within Rs 15 lakh to Rs 20 lakh.
"Given the inherent leverage and higher risk in derivatives, this recalibration in minimum contract size, in tune with the growth of the market, would ensure that an inbuilt suitability and appropriateness criteria for participants is maintained as intended," SEBI said.
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“Increasing the contract size can preempt small traders who have been hyper active in the F&O segment,” said VK Vijayakumar, chief investment strategist at Geojit Financial Services.
Limiting weekly index expiry: According to SEBI’s consultation paper in July, there is hyperactive trading in index options on expiry day, with average person holding period in minutes, accompanies by increased volatility in the value of index through the day and at expiry. “All this has implications for investor protection and market stability, with no discernable benefit towards sustained capital formation,” it said.
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The regulator has decided to rationalize index derivatives products offered by exchanges which expire on weekly basis. Therefore, each exchange will provide derivative contracts for only one of its benchmark index with weekly expiry.
“Single index expiry for weekly contracts per exchange will limit uncovered/ naked option selling due to lesser avenues,” Sanghvi said.
Rohit Agarwal, CEO - Funds Business at Dovetail Capital says limiting weekly expiries to a single index on NSE and BSE could encourage a shift in trading volumes towards GIFT City, which still offers a wider range of weekly options.
“From an FPI perspective, this creates an attractive opportunity for those seeking flexibility in trading strategies,” he added.
Intraday monitoring of position limits: Amid large volumes of trading on expiry day, there is a possibility of undetected intra-day positions beyond permissible limits. To address this risk, SEBI has decided that existing position limits for equity index derivatives shall also be monitored intra-day by exchanges. This rule will be applicable from April 1, 2025.
Increase in tail risk coverage on the day of options expiry: Considering the increased speculative activity around options positions and attendant risks on the day of options contracts expiry, SEBI will increase the tail risk coverage by levying an additional ELM of 2 per cent for short options contracts. This measure shall be effective from November 20, 2024
According to Tapse, market regulator has attempted with few steps and measures to strengthen index derivative framework to protect investors and improve market stability.
“We believe this was the need of the hour considering the way Indian markets are going on the top and such measures can safeguard traders, market participants at the time of high volatility days,” he added.
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