SEBI's Proposed Measures To Curb Speculative Trading In Index Derivatives

The SEBI's announcement arose from concerns about the exponential rise in trading volume within the futures and options (F&O) segment.

Understanding Derivatives

Derivatives are financial contracts whose value is derived from an underlying asset, such as stocks, commodities, or currencies. Index derivatives derive their value from the underlying index. Two primary types of derivatives are futures and options. In a futures contract, the buyer is obliged to purchase the underlying asset at a predetermined price on a specified date. Conversely, an options contract gives the investor the right, but not the obligation to trade the underlying assets at a specific price on a predetermined date.

SEBI's Proposed Measures

Increase in Minimum Contract Size:

SEBI proposes to increase the minimum contract size for index derivatives from the current range of Rs 5 lakh to Rs 10 lakh, to Rs 15 lakh to Rs 20 lakh. This range will further increase to Rs 20 lakh to Rs 30 lakh after six months.

Upfront Collection of Option Premium:

Brokers will be required to collect option premiums upfront from clients.

Intraday Monitoring of Position Limits:

SEBI suggests that Market Infrastructure Institutions (MIIs), such as clearing corporations or stock exchanges, should monitor position limits for index derivative contracts on an intraday basis. Currently, position limits are monitored at the end of the day which can lead to undetected intraday positions beyond permissible limits.

Rationalization of Weekly Index Products:

To reduce speculative trading, SEBI recommends limiting weekly options contracts to a single benchmark index per exchange. The current practice of offering weekly expiry index derivatives contracts on multiple indices and trading days results in speculative money moving from one expiry to another daily.

Removal of Calendar Spread Benefit on Expiry Day:

SEBI proposes that the margin benefit for calendar spread positions should not be provided for positions involving any contracts expiring on the same day.

Rationalization of Options Strikes:

The strike price of an option is the price at which a put or call option can be exercised. SEBI suggests a uniform strike interval up to a fixed coverage of 4% near the prevailing index price with intervals increasing as strikes move away from the prevailing price.

Increase in Margin Near Contract Expiry:

SEBI proposes increasing margins on the day before expiry and on the expiry day itself. The Extreme Loss Margin (ELM) will be increased by 3% at the start of the day before expiry and by an additional 5% on the expiry day.

The Union Budget 2024-25 announced on July 23 included a proposal to double the Securities Transaction Tax (STT) on F&O securities effective October 1, 2024.

SEBI's consultation paper highlighted that in FY 2023-24, 92.50 lakh unique individuals and proprietorship firms traded in the NSE index derivatives segment cumulatively incurring a trading loss of Rs 51,689 crore. Only 14.22 lakh investors about 15% made a net profit.

The measures such as rationalizing strike prices and increasing margins near contract expiry are designed to reduce speculative hyperactivity that leads to increased volatility during the last half-hour of trading on expiry days.

 Click Here To Read/Download Consultation Paper