The Securities and Exchange Board of India (SEBI) has proposed tightening the rules for index derivatives, aiming to curb speculative trading. This move comes in the wake of concerns regarding the surge in retail investor participation in the derivatives segment, fueled by the recent increase in securities transaction tax (STT) on futures and options trading. Earlier, the Economic Survey had expressed concerns about the rising interest of retail investors in derivative trading, highlighting that speculative trade has no place in a developing country. The survey also pointed out that the sharp rise in retail investor participation in F&O trading is likely driven by gambling instincts.
To address these concerns, SEBI has proposed several measures, including rationalizing weekly index products, intra-day monitoring of position limits, rationalizing strike prices, removing calendar spread benefits on the expiry day, and increasing the near-contract expiry margin. These proposed measures are aimed at enhancing investor protection and promoting market stability in derivative markets. Derivatives markets assist in better price discovery, help improve market liquidity, and allow investors to manage their risks better. However, the regulator acknowledges that bursts of speculative hyperactivity in derivative markets, particularly by individual players, can detract from sustained capital formation by endangering both investor protection and market stability.
SEBI’s consultation paper proposes a two-phase revision of the minimum contract size for index derivative contracts. Under Phase 1, the minimum value of the derivatives contract at the time of introduction should be between Rs 15 lakh and Rs 20 lakh. After six months, in Phase 2, the minimum value of the derivatives contract will be between Rs 20 lakh and Rs 30 lakh. The regulator highlighted that the last revision of the minimum contract size requirement for derivative contracts (Rs 5 lakh to Rs 10 lakh) was in 2015.
Further, SEBI suggests rationalizing options strikes with a uniform strike interval of 4 per cent around the prevailing index price and expanding strike intervals beyond the initial coverage to reduce the number of strikes further from the index price. The proposal outlines a maximum of 50 strikes at the time of introduction, with new strikes introduced daily to maintain these intervals.
In an effort to discourage excessive speculation, SEBI proposes that members collect option premiums from clients upfront. Additionally, SEBI suggests removing calendar spread benefits on the expiry day, meaning there should be no margin benefit for calendar spread positions on contracts expiring on the same day. To enhance market stability, SEBI proposes that position limits for index derivatives be monitored intraday by clearing corporations and stock exchanges. Furthermore, weekly options contracts should be provided on a single benchmark index of exchange, and the Extreme Loss Margin (ELM) should be increased by 3 per cent the day before expiry and further increased by 5 per cent on the expiry day.
The regulator’s proposals are intended to mitigate the risks associated with speculative trading in index derivatives. SEBI has invited public comments on these proposals until August 20. A study conducted by SEBI in January 2023 found that 89 per cent of individual traders in the equity F&O segment incurred losses. For FY2023-24, 92.50 lakh unique individuals and firms traded in NSE’s index derivatives, incurring a cumulative trading loss of Rs 51,689 crore, excluding transaction costs. Notably, about 85 per cent of these traders made net losses.
Futures and Options trading involve contracts that derive their value from an underlying asset, such as stocks or commodities. Futures contracts obligate the buyer and seller to transact at a predetermined future date and price, while options give the holder the right, but not the obligation, to buy or sell the asset at a set price within a specific period. These financial instruments are used for hedging risks, speculating on price movements, and arbitraging price differences. However, they come with significant risks, including leverage risk and market volatility, which can lead to substantial losses.
Last month, the SEBI board approved stricter norms for the entry of individual stocks in the derivatives segment. This proposal aims to weed out stocks with consistently low turnover from the F&O segment of the bourses.
