Market Mania: How SEBI Wants to Protect Retail Investors from F&O Mess

Capital markets regulator the Securities & Exchange Board of India has proposed new measures in an attempt to protect investors and maintain market stability in the booming derivatives market.

On Tuesday, SEBI proposed seven steps, including increasing the minimum contract size for F&O to Rs 20 lakh and limiting weekly option contracts.

It highlighted that 92.5 lakh retail traders and proprietorship firms incurred a trading loss of Rs 51,689 crore in FY24. SEBI issued a consultation paper on measures to strengthen the index derivatives framework for increased investor protection and market stability.

SEBI proposed to revise the minimum contract size for index derivatives contracts in a phased manner. The minimum value of the derivatives contract at the time of induction is proposed to be between Rs 15 lakh to Rs 20 lakh. After six months, the minimum value will be between Rs 20 lakh to Rs 30 lakh.

At present, the minimum contract size requirement for derivative contracts is Rs 5 lakh to Rs 10 lakh, last set in 2015.

SEBI also suggested reducing weekly option contracts. Currently, there are index-based contracts that expire every day. The markets watchdog is proposing to allow weekly contracts of one index of an exchange. Once approved, there will be two expiries every week.

In addition, SEBI proposed the following measures to be adopted by stock exchanges and clearing corporations.

Rationalization of strike prices for options: According to the consultation paper, SEBI has proposed to rationalize the existing strike price introduction methodology. “Strike interval to be uniform near prevailing index price (4 per cent around prevailing price) and the interval to increase as the strikes move away from prevailing price (around 4 per cent to 8 per cent),” it said. It added that not more than 50 strikes should be introduced for an index derivatives contract at the time of contract launch.

Upfront Collection of Options Premium: To prevent any undue intraday leverage to end clients and to discourage any market-wide practice of allowing position beyond the collateral at the end client level, it is desirable to mandate the collection of options premium upfront from the options buyer.

Currently, SEBI has mandated upfront collection of 100 per cent margin for trades. There is no explicit stipulation that option premiums have to be paid collected upfront. The consultation paper suggests collecting the premiums in entirety upfront.

Removal of calendar spread benefit on expiry day: The regulator also proposed that given the skew in volumes witnessed on the expiry day vis-à-vis other non-expiry days and the inherent basis and liquidity risk present therewith, the margin benefit for calendar spread position would not be provided for positions involving any of the contract expiring on the same day.

Intraday monitoring of position limits: Currently, position limits for various participants/ product types are specified by SEBI. These limits are monitored by MIIs at the end of the day.  “Given the evolving market structure, the position limits for index derivative contracts shall also be monitored by the clearing corporations/ stock exchanges on an intra-day basis, with an appropriate short-term fix, and a glide path for full implementation, given the need for corresponding technology changes,” SEBI proposed.

Minimum contract size: SEBI has suggested increasing the minimum value of derivatives contracts from Rs 5-10 lakh to Rs 15-20 lakh in the first phase and Rs 20-30 lakh in the second phase. Increasing the contract size by multiple times will make it harder for retail investors to participate in derivatives trading. "Given the inherently higher risk in derivatives and a large amount of implicit leverage, an increase in minimum contract size would result in reverse sachetization of such risk-bearing products," according to SEBI paper.

Rationalization of weekly index products: Considering there is an expiry of weekly contracts on all five trading days of the week, SEBI has proposed that weekly options contracts to be provided on single benchmark index of exchange to enhance investor protection and promote market stability in derivatives markets.

Increase in margin contract near expiry: To address the issue of high implicit leverage in options contracts near expiry, the regulator suggested that Extreme Loss Margin (ELM) to be increased by 3-5 per cent.

Concerns around F&O Trading

Recently, SEBI chief Madhabi Puri Buch expressed concerns over the rapid growth in derivatives trading, highlighting potential broader economic implications.

The Economic Survey 2024, highlighted this issue saying that derivatives trading holds the potential for outsized gains. Thus, it caters to humans’ gambling instincts and can augment income if profitable. These considerations are likely driving active retail participation in derivatives trading.

“On a global scale, derivatives trading tends to result in financial losses for the majority of investors,” it said. According to SEBI data, nine out of 10 individual investors in the equity F&O segment incurred net losses during both the years FY19 and FY22. There was a massive significant increase of over 500 per cent in the number of individual traders in the equity derivatives segment in FY22 compared to FY19.

In the Union Budget 2024, Finance Minister Nirmala Sitharaman raised securities transaction tax (STT) on securities to 0.02 per cent in futures and 0.1 per cent in options.