SEBI’s Proposed Reforms for Index Derivatives: What You Need to Know
The Securities and Exchange Board of India (SEBI) recently unveiled a consultation paper outlining proposed reforms aimed at strengthening the framework for index derivatives (futures and options). The primary goal of these reforms is to enhance investor protection and ensure market stability while fostering sustained capital formation. Here’s a comprehensive look at the proposed measures, their potential impact on traders, and expert opinions.
1. Rationalization of Strike Prices for Options
Current Practice:
Currently, Nifty and Bank Nifty options cover approximately 7-8% of the index movement per day, with up to 70 and 90 strike prices, respectively. Additional strikes are introduced as needed.
Proposed Changes:
SEBI proposes limiting the number of strike prices to a maximum of 50 at the time of contract launch. The strike intervals will be uniform and close to the prevailing price (around 4%), potentially extending up to 8% if necessary. This aims to streamline the range of options available and reduce market complexity.
Impact on Traders:
Traders may experience fewer strike prices to choose from, potentially simplifying decision-making. However, this could also limit flexibility in managing options positions.
2. Upfront Collection of Options Premium
Current Practice:
Currently, while margin is required for futures and short options positions, there is no upfront collection of premiums from options buyers.
Proposed Changes:
SEBI recommends collecting options premiums on an upfront basis. This measure seeks to ensure that options buyers have sufficient funds to cover their trades from the outset.
Impact on Traders:
Traders will need to arrange for the premium payment at the time of purchase, which might affect liquidity. However, it could lead to a more robust risk management framework.
3. Removal of Calendar Spread Benefit on Expiry Day
Current Practice:
The calendar spread margin benefit currently reduces margin requirements for positions with different expiries.
Proposed Changes:
The proposal suggests eliminating the calendar spread margin benefit for contracts expiring on the same day. This adjustment is intended to increase margin requirements as expiry approaches.
Impact on Traders:
Traders may face higher margin requirements on expiry days, potentially impacting their trading strategies and increasing costs.
4. Intraday Monitoring of Position Limits
Current Practice:
Position limits are monitored at the end of the trading day by Market Infrastructure Institutions (MIIs), such as Clearing Corporations and Stock Exchanges.
Proposed Changes:
SEBI proposes monitoring position limits on an intraday basis. A short-term fix and a gradual implementation plan will be introduced.
Impact on Traders:
Intraday monitoring could lead to more frequent adjustments to positions and margin requirements, increasing the need for real-time risk management.
5. Minimum Contract Size Adjustments
Current Practice:
The minimum contract size was set between Rs 5 lakh and Rs 10 lakh in 2015.
Proposed Changes:
In Phase 1, the minimum contract size will increase to Rs 15 lakh to Rs 20 lakh. In Phase 2, after six months, it will rise further to Rs 20 lakh to Rs 30 lakh.
Impact on Traders:
Higher minimum contract sizes may limit participation for smaller traders and increase capital requirements for new and existing traders.
6. Rationalization of Weekly Index Products
Current Practice:
The weekly expiry of index derivatives results in an expiry every day of the week across various indices and exchanges.
Proposed Changes:
SEBI proposes limiting weekly expiry to one benchmark index per exchange. This aims to streamline trading and reduce market fragmentation.
Impact on Traders:
Traders may find a more organized expiry schedule, potentially reducing confusion and making it easier to manage positions.
7. Increase in Margin Near Contract Expiry
Current Practice:
No additional margin is required in the last two trading days before expiry.
Proposed Changes:
An additional Extreme Loss Margin (ELM) of 3% will be collected starting on the penultimate day of the contract expiry, increasing to 5% on the last day.
Impact on Traders:
Increased margin requirements near expiry could impact liquidity and require traders to manage their positions more conservatively.
Why SEBI Is Proposing These Measures
SEBI’s chief, Madhabi Puri Buch, highlighted a significant macro concern: an annual loss of Rs 50,000-60,000 crore of household savings due to derivatives trading. This capital could be better utilized in IPOs, mutual funds, or other productive investments. SEBI believes that excessive speculative trading in futures and options is a major issue, with retail investors accounting for around 50% of trading volumes in index derivatives. The proposal aims to curb excessive speculation and protect retail investors by implementing more stringent measures and ensuring a more stable market environment.
Expert Opinions and Market Reactions
Experts generally view SEBI’s proposed measures as a step towards enhancing market stability and protecting retail investors. However, there are concerns about the potential impact on liquidity and the increased burden on traders, especially smaller ones. The reforms could lead to a more controlled and less speculative trading environment, which is seen as beneficial for long-term market health.
In conclusion, SEBI’s proposed reforms are designed to create a more stable and investor-friendly derivatives market. While these changes may introduce new challenges for traders, they also aim to address critical issues related to speculation and market stability. As the consultation period progresses, stakeholders will have the opportunity to provide feedback and influence the final implementation of these measures.
SEBI, Index Derivatives, Futures and Options, Investor Protection, Market Stability, Derivatives Trading, SEBI Proposals
