The Securities and Exchange Board of India (SEBI) Tuesday tightened the norms for equity derivatives (F&Os or futures and options) trading by raising the entry barrier and making it more expensive for retail investors to trade in F&Os. The new rules will come into effect from November 20, 2024.
The market regulator announced a set of six measures which include increasing the contract size for index futures and index options to Rs 15 lakh from the present contract size between Rs 5 lakh and Rs 10 lakh, and rationalisation of weekly index derivatives products by allowing each exchange to provide contract for only one of its benchmark index with weekly expiry.
The move follows the government’s decision in Budget 2024-25 to raise the securities transaction tax on F&O trading (STT on futures from 0.0125 per cent to 0.02 per cent and that on options from 0.0625 per cent to 0.1 per cent). It is also in line with growing concerns within SEBI and the Reserve Bank of India that surging F&O volumes have started impinging on capital formation and posing a systemic risk to India’s economic growth.
A senior regulatory source had told The Indian Express that a sharp rise in F&O trading volumes had grown to become a macro problem in just two years with household savings finding their way into these instruments. It was seen to be hurting capital formation, investment and growth.
F&Os are derivative contracts that derive their value from underlying assets that include stocks, commodities, currencies etc. Based on their expectation of future price movement, investors enter into a contract to buy or sell the asset in ‘lots’ (a lot has multiple units of the asset) by paying a small margin amount.
Data sourced from SEBI bulletin on F&Os showed a sharp jump in both turnover and number of contracts traded. While F&O combined turnover at BSE and NSE jumped more than four times to Rs 9,504 lakh crore in May 2024 from Rs 2,189 lakh crore in May 2022, the number of contracts traded surged by more than five times to 1,373 crore from 262 crore during the period.
The other measures announced on Tuesday include upfront collection of option premium from options buyers, intraday monitoring of the position limit, increase in tail risk coverage — or the chance of a loss occurring due to a rare event — on the day of options expiry, and removal of calendar spread treatment on the expiry day.
These measures are expected to strengthen equity index derivatives for increased investor protection and market stability.
At present, the size for index futures and index options is between Rs 5 lakh and Rs 10 lakh. This limit was last set in 2015. Since then, broad market values and prices have increased by around three times.
“It has been decided that a derivative contract shall have a value not less than Rs 15 lakh at the time of its introduction in the market,” SEBI said in a circular on Tuesday. Further, 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 lakhs 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, the markets regulator said.
In order to address the issue of excessive trading in index derivatives on expiry day, SEBI has decided to rationalize index derivatives products offered by exchanges which expire on weekly basis. “Henceforth, each exchange may provide derivatives contracts for only one of its benchmark index with weekly expiry,” it said.
As part of the new framework, SEBI has decided to increase the tail risk coverage by levying an additional Extreme Loss Margin (ELM) of 2 per cent for short options contracts, effective November 20, 2024. This will help curb the heightened speculative activity around options positions and the attendant risks on the day of options contracts expiry.
The increase in tail risk coverage would be applicable for all open short options at the start of the day, as well on short options contracts initiated during the day that are due for expiry on that day.
The markets regulator said that options prices move in a non-linear way and carry very high implicit leverage. These are timed contracts with the possibility of fast-paced price appreciation or depreciation.
“In order 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 option buyers by the Trading Member (TM)/ Clearing Member (CM), the SEBI said.
The upfront margin collection requirement, to be effective from February 1, 2025, will also include net options premium payable at the client level. The same may be included in the intraday snapshots conducted by Clearing Corporations for verification of upfront collection of margins, and for imposition of penalty in the event of non-compliance, it said.
The regulator further noted that the 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.
“Given the relatively very large volumes witnessed on the expiry day vis-à-vis future expiry days, and the enhanced basis risk that it represents, it has been decided that the benefit of offsetting positions across different expiries (‘calendar spread’) shall not be available on the day of expiry for contracts expiring on that day,” it said. This new measure which will come into effect from February 1, 2025.
Amidst the large volumes of trading on expiry day, SEBI said that there is a possibility of undetected intraday positions beyond permissible limits during the course of the day.
To address the risk of position creation beyond permissible limits, the regulator said that existing position limits for equity index derivatives would henceforth also be monitored intra-day by exchanges.
For this purpose, stock exchanges shall consider minimum 4 position snapshots during the day. The measure shall be effective for equity index derivatives contracts from April 01, 2025
The measures to strengthen the equity index derivatives come amid concerns raised by the government and the regulator over the surge in trading volumes in futures and options, and a majority of investors losing money in the segment.
