Sebi Proposes New Measures to Limit Speculative Trading in Index Derivatives

On Tuesday, the Securities and Exchange Board of India (Sebi) proposed stricter regulations for index derivatives. The new rules include revising the minimum contract size and requiring upfront collection of option premiums to curb speculative trading. This follows the government's recent increase in the securities transaction tax (STT) on futures and options trades from October 1, as announced in the Union Budget.

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The Economic Survey had earlier raised concerns about the rising interest of retail investors in derivative trading. It highlighted that speculative trading is not suitable for a developing country and suggested that the surge in retail investor participation in Futures and Options (F&O) trading might be driven by gambling instincts. Sebi's consultation paper includes measures such as rationalising weekly index products, intra-day monitoring of position limits, rationalising strike prices, removing calendar spread benefits on expiry day, and increasing near contract expiry margins.

Proposed Changes to Contract Sizes

Sebi has proposed revising the minimum contract size for index derivative contracts in two phases. Initially, the minimum value should be between Rs 15 lakh and Rs 20 lakh. After six months, this range should increase to between Rs 20 lakh and Rs 30 lakh. The last revision of the minimum contract size requirement for derivative contracts was set between Rs 5 lakh and Rs 10 lakh in 2015.

The regulator also suggested rationalising option strikes with a uniform strike interval of 4 per cent around the prevailing index price. Expanded strike intervals beyond initial coverage aim to reduce the number of strikes further from the index price. A maximum of 50 strikes will be introduced initially, with new strikes added daily to maintain these intervals.

Upfront Collection of Option Premiums

Sebi proposed that members should collect option premiums from clients upfront. Additionally, it suggested removing calendar spread benefits on expiry day, meaning no margin benefit for calendar spread positions on contracts expiring on the same day. Position limits for index derivatives should be monitored intraday by clearing corporations and stock exchanges.

Weekly options contracts should be provided on a single benchmark index of exchange. The Extreme Loss Margin (ELM) should increase by 3 per cent the day before expiry and by another 5 per cent on expiry day. These measures aim to enhance investor protection and promote market stability in derivative markets.

Impact on Retail Investors

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. About 85 per cent of these traders made net losses.

Derivatives markets assist in better price discovery, improve market liquidity, and allow investors to manage their risks better. However, 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.

Stricter Norms for Individual Stocks

Last month, Sebi's board approved stricter norms for the entry of individual stocks into the derivatives segment. This proposal aims to weed out stocks with consistently low turnover from the F&O segment of the bourses.

Futures and Options trading involves contracts that derive their value from an underlying asset like stocks or commodities. Futures contracts obligate buyers and sellers to transact at a predetermined future date and price. Options give holders the right but not the obligation to buy or sell an 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 but come with significant risks such as leverage risk and market volatility, which can lead to substantial losses.

Sebi has sought public comments on these proposals until August 20. The proposed measures aim to enhance investor protection while promoting market stability in derivative markets.