Market regulator Securities and Exchange Board of India (SEBI), in a consultation paper, has proposed certain near-term measures for the index derivatives segment. It includes rationalisation of strike price for options, upfront collection of options premium, removal of calendar spread benefit on expiry day, intraday monitoring of position limits, increasing minimum derivative contract size by three to four times, rationalisation of weekly index products and increase in margin near contract expiry.
Given the changing market dynamics in the equity derivatives segment in recent years with increased retail participation, offering of short-tenure index options contracts and heightened speculative trading volumes in index derivatives on the expiry date, SEBI seeks to introduce measures to enhance investor protection and promote market stability in derivative markets, while ensuring sustained capital formation.
For FY23-24, 9.25mn (million) unique individuals and proprietorship firms traded in the index derivatives segment of NSE and cumulatively incurred a trading loss of Rs51,689 crore, excluding transaction costs.
Further, of these 9.2mn unique investors, 1.42mn investors made a net profit i.e., about 85 out of 100 made a net trading loss. A SEBI study found that over and above the trading losses, the loss-makers expended an additional 23% of trading losses as transaction costs, while profit-makers spent an additional 15% of their trading profits as transaction costs during FY21-22.
"After considering the transaction costs, the outcome for FY23-24 will likely be very comparable to our FY21-22 study, which found nine out of 10 losing money. On the other side, it has been observed that larger non-individual players that are highfrequency algo-based proprietary traders and/ or foreign portfolio investors (FPIs), are, in general, making offsetting profits," SEBI says.
Currently, options strikes are introduced at uniform price intervals around prevailing index value by exchanges. For instance, NIFTY contracts have 35 in-the-money and 35 out-of-money strikes at the time of introduction with an interval of 50 points. BANKNIFTY contracts have 45 in-the-money and 45 out-of-money strikes at the time of introduction. Due to this, the options strikes cover roughly 7% to 8% of index movement around the prevailing index price at the time of introduction.
In addition, there are reserve strikes which enable exchanges to launch new strikes during intra-day movement in index. Further, on daily basis, additional strikes are introduced if movement in the index warrants.
SEBI proposal says strike interval to be uniform near the prevailing index price (4% around the prevailing price) and the interval to increase as the strikes move away from the prevailing price (around 4% to 8%). "Not more than 50 strikes to be introduced for an index derivatives contract at the time of contract launch. New strikes to be introduced to comply on a daily basis. Exchanges to uniformly implement and operationalise the principles after joint discussion."
There is a stipulation for upfront collection of margin for futures position (both long and short) as well as options position (only short options require margin whereas long options require payment of options premium by buyers). There is no explicit stipulation of upfront collection of options premium from options buyer by members.
To avoid any undue intraday leverage to end client and to discourage any market-wide practice of allowing positions beyond the collateral at the end client level, SEBI says it is desirable to mandate the collection of options premium upfront by a trading member (TM) or clearing member (CM) from the options buyer.
The market regulator also proposes to remove the calendar spread benefit on the expiry day. It says, "While there is a valid reason for the margin benefit, expiry day can see significant basis risk where the derivative value for the contract expiring can move very differently from the derivative value on away month expiry. This is particularly true with the level of hyperactivity on expiry day in contrast to the activity in the away month expiry. The element of liquidity risk is heightened as away week or month options are generally not very liquid, and hence closing both legs of the calendar spread positions could result in a net loss."
At present, the minimum contract size requirement for derivative contracts (i.e., Rs5 lakh to Rs10 lakh) was last set in 2015. During the last nine years, the benchmark indices have gone up by nearly three times.
SEBI says, given the inherently higher risk in derivatives and a large amount of implicit leverage, an increase in minimum contract size would result in reverse sachetisation of such risk-bearing products.
The market regulator proposes to revise the minimum contract size in two phases. In the first phase, the minimum value of the derivatives contract at the time of introduction would be between Rs15 lakh and Rs20 lakh. After six months, in the second phase, the minimum value of the derivatives contract would be between the interval of Rs20 lakh to Rs30 lakh, SEBI says.
Stock exchanges offer weekly expiry index derivatives contracts in addition to monthly contracts. There is an expiry of such weekly contracts on all five trading days of the week across different indices or exchanges mirroring 0 DTE (zero-day to expiry) construct, resulting in speculative money moving from one expiry of the index to another every single day.
Expiry day trading is almost entirely speculative, SEBI says. "Given there is an expiry of weekly contracts on all five trading days of the week combined with previous findings on increased volatility on expiry day and within that increased volatility during closing time, speculative activity created near contract expiry and poor profitability outcome for individual investors in futures and options (F&O) segment, rationalisation is warranted in the product offering."
Last month, SEBI appointed an expert working committee to tackle this issue and the panel has now put forth several recommendations aimed at curbing the unbridled rise in derivatives volume.
The derivatives market in India has seen explosive growth, with overall derivative turnover jumping from Rs210trn (trillion) in FY17-18 to Rs500trn in FY23-24. Retail participation has surged, with individual investors in index options increasing from 2% in FY19-18 to 41% in FY23-24.
While SEBI chairperson Madhabi Puri Buch has stated that this growth doesn't pose systemic risks due to robust margining systems, there are significant social concerns. Anecdotal evidence suggests many individuals borrow money to trade options with hopes of quick profits, despite a SEBI study showing that nearly 90% of retail traders lose money on option bets.
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