The Securities and Exchange Board of India (SEBI) has unveiled a series of significant measures aimed at strengthening the framework for index derivatives. These changes are designed to enhance investor protection and improve overall market stability. One key initiative is the shift to weekly expiries for derivative contracts, allowing each exchange to offer derivatives for only one benchmark index per week.
These measures come in response to the highly speculative nature of index derivative trading, particularly on expiry days. SEBI recognizes the need to address the heightened risks associated with this trading environment.
Increased Minimum Trading Amount
In a notable policy change, SEBI has raised the minimum trading amount for derivatives from the current range of ₹5-10 lakh to ₹15 lakh. This new requirement will be implemented gradually, with the goal of ultimately increasing it to between ₹15 lakh and ₹20 lakh. According to SEBI’s press release, “the lot size shall be fixed in such a manner that the contract value of the derivative on the day of review is within ₹15 lakh to ₹20 lakh.”
Phased Implementation of New Norms
The new derivative trading regulations will be rolled out in phases starting November 20. Key features include:
- Introduction of index derivative contracts with weekly expiries.
- Increased contract sizes.
- Enhanced tail risk coverage through the imposition of an additional Extreme Loss Margin (ELM).
By February 1, 2025, SEBI will mandate upfront collection of option premiums from buyers, alongside the removal of calendar spread treatment on expiry days. Additionally, by April 1, 2025, there will be intraday monitoring of position limits, effectively eliminating daily expiries.
Rationale Behind the Changes
SEBI noted that expiry day trading in index options often exhibits speculative behavior, particularly when option premiums are low. With stock exchanges offering contracts that expire daily, there has been a surge in trading activity on expiry days, characterized by brief average position holding periods and increased volatility. The regulator stated, “All this has implications for investor protection and market stability, with no discernible benefit towards sustained capital formation.”
To mitigate these risks, SEBI has mandated that each exchange can offer derivative contracts only for one index per week.
Review of Contract Sizes
Recognizing the substantial growth in market value—tripling since the contract sizes were established in 2015—SEBI has deemed it necessary to review and adjust the minimum contract sizes. The regulator’s statement emphasized that “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.”
Higher Margin Requirements
The newly introduced Extreme Loss Margin (ELM) will help cover potential extreme market events. Given the observed speculative activity on expiry days, SEBI has decided to require an additional 2% ELM from investors. This applies to all open short options at the start of the day and any new short options contracts initiated that day. For instance, if the weekly expiry for an index contract occurs on the 7th of the month, all options expiring that day will incur an additional 2% ELM.
Upfront Collection of Premiums
In a move aimed at curbing excessive intraday leverage, SEBI has mandated that brokers collect net option premiums upfront. This decision seeks to prevent any practices that might allow clients to hold positions exceeding their collateral. The regulator stated, “In order to avoid any undue intraday leverage to the end-client, it has been decided to mandate the collection of options premium upfront from option buyers.”
Elimination of Calendar Spread Benefits
SEBI has decided to discontinue the calendar spread advantage for contracts expiring on the same day, citing that their values can fluctuate significantly compared to future-expiring contracts. The regulator noted, “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 shall not be available on the day of expiry for contracts expiring on that day.”
Enhanced Intraday Monitoring of Position Limits
Previously, position limits for index contracts were assessed at the end of each trading day. Moving forward, SEBI has instructed stock exchanges and clearing corporations to monitor these limits at least four times daily, with the option to increase frequency as necessary. The statement highlighted the risk of undetected intraday positions exceeding permissible limits during high-volume trading on expiry days.
In conclusion, these comprehensive changes introduced by SEBI reflect a proactive approach to enhancing market integrity and protecting investors amidst the evolving landscape of index derivatives trading. As these regulations take effect, market participants will need to adapt to the new framework, ensuring they are equipped to navigate the changing environment effectively.
