This article explores the intricacies of SEBI’s pivotal consultation paper
Recently, the Securities and Exchange Board of India (SEBI) released a pivotal consultation paper proposing several measures aimed at reforming the framework for index derivatives, including futures and options. The primary goals of these measures are to enhance investor protection, ensure market stability, and promote healthy capital formation in derivatives markets. This article explores the intricacies of these proposals, analyzes their potential impacts on traders and the broader market, and discusses expert opinions on the matter.
Overview of Proposed Changes
SEBI’s proposed measures are extensive and target various aspects of the trading of index derivatives, reported by Business Standard. Here is a detailed look at each proposal:
1. Rationalization of Strike Price for Options
Current Practice: Options strikes for Nifty and Bank Nifty cover about 7-8% of index movement on any given day, with up to 70 and 90 strikes available, respectively.
Proposal: Limit the number of strikes to 50 at the time of contract launch, with a uniform strike interval near the prevailing price.
Impact: This change is intended to simplify the choices available to investors, potentially reducing complexity and focusing on the most traded strike prices.
2. Upfront Collection of Options Premium
Current Practice: While margins are collected for futures and short options positions, there is no such requirement for the upfront collection from options buyers.
Proposal: Implement the collection of option premiums upfront.
Impact: This measure aims to reduce credit risk in the system by ensuring that funds are secured before trade execution.
3. Removal of Calendar Spread Benefit on Expiry Day
Current Practice: Calendar spread margin benefits are available on expiry days, reducing margin requirements.
Proposal: Eliminate these margin benefits for contracts expiring on the same day.
Impact: This could increase the cost of trading on expiry days, potentially reducing high-frequency trading behavior that exploits these margins.
4. Intraday Monitoring of Position Limits
Current Practice: Position limits are monitored at the end of the day.
Proposal: Monitor position limits on an intra-day basis.
Impact: This would enhance market integrity and prevent positions from exceeding set limits during the trading day.
5. Minimum Contract Size Increase
Current Practice: The minimum contract size has been set between Rs 5 – Rs 10 lakh since 2015.
Proposal: Increase the minimum contract size to Rs 15 – Rs 20 lakh initially, moving to Rs 20 – Rs 30 lakh within six months.
Impact: This change aims to discourage small retail investors from the high-risk derivatives market.
6. Rationalization of Weekly Index Products
Current Practice: There is a weekly expiry every day of the week for various indices.
Proposal: Limit weekly expiries to one benchmark index per exchange per week.
Impact: This is expected to simplify trading and reduce speculative behavior.
7. Increase in Margin Near Contract Expiry
Current Practice: No additional margins are required during the last two trading days.
Proposal: An additional 3% Extreme Loss Margin (ELM) on the penultimate day and 5% on the last day.
Impact: This would provide additional security against potential large losses as contracts approach expiry.
SEBI’s Rationale and Expected Outcomes
SEBI has expressed concern over the Rs 50,000 – Rs 60,000 crore annual loss of household savings through derivatives trading. This loss, according to SEBI, diverts funds from potentially more productive investments like IPOs and mutual funds. The regulatory body aims to curb excessive speculative trading, which predominantly involves retail investors, who account for about 50% of trading volumes in index derivatives.
Expert Opinions and Industry Reactions
Dhiraj Relli from HDFC Securities points out that these measures, especially the rationalization of weekly expiries, will likely impact trading volumes, which have been buoyed by these expiries. Meanwhile, investment firm Jefferies notes that the changes could have a divergent impact on market players, particularly affecting exchanges and retail-focused brokers.
SEBI’s proposed measures for the index derivatives market are transformative and aim to promote a healthier trading environment. While intended to protect investors and stabilize the market, these changes will require adjustments from market participants. The feedback from the ongoing public consultation, ending on August 20, 2024, will be crucial in refining these proposals before they are finalized. As the derivatives market awaits these changes, traders and firms must prepare for a new trading landscape that prioritizes stability and investor protection over high-risk speculative activities.
