Securities and Exchange Board of India (SEBI) put a stricter framework in place for equity index derivatives by increasing the minimum contract size and mandating upfront collection of option premiums to curb speculative trading. SEBI also introduced new stress testing methodologies for the equity derivatives segment to better account for the changing market dynamics and assess risks.
Other measures announced by the market regulator included intra-day monitoring of position limits, removal of calendar spread benefit on expiry day, rationalisation of weekly index derivatives and increased tail risk coverage.
These measures, aimed at protecting investors and maintaining market stability, particularly in the high-risk environment of index options trading on expiry days, will become effective in a phased manner starting 20 November 2024, SEBI says in a circular.
The market regulator introduced a series of six measures, including raising the contract size for index futures and index options from Rs5 lakh to Rs10 lakh to Rs15 lakh. Additionally, SEBI is rationalising the weekly index derivatives offerings, allowing exchanges to provide contracts for only one benchmark index with a weekly expiry.
These changes follow the government's 2024-25 Budget decision to increase the securities transaction tax (STT) on F&O trading, raising the rate on futures from 0.0125% to 0.02% and on options from 0.0625% to 0.1%.
This move also aligns with growing concerns from SEBI and the Reserve Bank of India (RBI) regarding the rapid increase in F&O volumes, which is seen as a potential risk to capital formation and economic growth in India.
The significant rise in F&O trading volumes has become a macroeconomic issue over the past two years, as household savings are increasingly funnelled into these instruments, adversely affecting investment and growth.
F&Os are derivative contracts whose value is derived from underlying assets such as stocks, commodities, and currencies. Investors engage in these contracts based on their expectations of future price movements, entering into agreements to buy or sell the asset in 'lots' by paying a small margin.
SEBI's data reveals a substantial increase in turnover and the number of contracts traded in F&Os. From May 2022 to May 2024, the combined turnover at Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) surged more than fourfold, reaching Rs9,504 lakh crore, while the number of contracts traded soared over fivefold from Rs262 crore to Rs1,373 crore.
Additional measures announced by SEBI include introducing upfront collection of option premiums from buyers, intraday monitoring of position limits, increased tail risk coverage to address the likelihood of losses from rare events, and removing calendar spread treatment on expiry day. These regulations are designed to enhance investor protection and promote market stability in equity index derivatives.
The current contract size for index futures and index options, which range between Rs5 lakh and Rs10 lakh, have not been adjusted since 2015, a period during which market values and prices have approximately tripled. SEBI has stated that all new derivative contracts will have a minimum value of Rs15 lakh upon their market introduction, with the lot size adjusted to maintain contract values between Rs15 lakh and Rs20 lakh.
Furthermore, starting 1 February 2025, SEBI will mandate the upfront collection of options premiums from option buyers by trading members (TMs) and clearing members (CMs). This requirement will encompass the net options premiums payable at the client level and will be integrated into the intraday snapshots conducted by clearing corporations to ensure compliance and enforce penalties for violations
Amid the significant trading volumes observed on expiry days, SEBI cautioned about potential basis risks, where the value of contracts expiring that day may fluctuate significantly compared to those expiring later. To address these concerns, SEBI has stated that the benefits of offsetting positions across different expiries (calendar spreads) will not apply on expiry days, a change effective 1 February 2025. SEBI says its new stress testing methodologies aim to enhance the determination of the minimum required corpus (MRC) for the core settlement guarantee fund (Core SGF).
SEBI's previous guidelines in October 2023 specified methods for assessing credit risk in clearing corporations (CCs). The stress testing was based on historical and hypothetical scenarios.
To manage the risk of exceeding permissible position limits, SEBI will now monitor existing position limits for equity index derivatives on an intraday basis. Exchanges are required to capture a minimum of four position snapshots throughout the trading day, with this measure taking effect on 1 April 2025.
