SEBI'S NEW DERIVATIVE DIRECTIONS

SEBI’S CONTROLS F&O SPECULATION

·SEBI has proposed series of measures to curtail speculative trading in index derivatives segment

BACKGROUND

• There are concerns regarding exponential rise in volume of trade in futures and options (F&O) segment, particularly by individual investors

• Move is intended to enhance investor protection and promote market stability in derivative markets

NEED OF DERIVATIVES MARKETS

• Assist in better price discovery

• Help improve market liquidity

• Allow investors to manage their risks better

ABOUT DERIVATIVES

• These are financial contracts that derive their value from underlying asset like Stocks, commodities, and currencies

• Can be traded on an exchange or over-the-counter

• Prices for derivatives derive from fluctuations in underlying asset

• These are usually leveraged instruments, which increases their potential risks and rewards

• Common derivatives include- Futures contracts, forwards, options, and swaps

TYPES OF DERIVATIVES

1. Index derivatives –Derive their value from underlying index

2. Futures and options

·Based on expectation of future price movement investors-Enter into a contract to buy or sell asset in ‘multiple units’, by paying small margin amount

Futures contract:

Obliges its buyer to purchase underlying asset at predetermined price on specified date

Options contract:

Gives its investor right but does not make it mandatory to trade underlying assets as stipulated at specific price on specified date

MEASURES PROPOSED BY SEBI

·Measures aim to ensure sustained capital formation by shielding against bursts of speculative hyperactivity-

1.Increase minimum contract size for index derivatives between Rs 15 lakh to Rs 20 lakh

After six months, this can be increased between intervals of Rs 20 lakh to Rs 30 lakh

Present minimum contract size requirement for derivative contracts is in between Rs 5 lakh to Rs 10 lakh

2.Upfront collection of option premium

• ·SEBI has recommended- Brokers can collect option premiums on an upfront basis from clients

• ·Currently, 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

3.Intraday monitoring of position limits

• Position limits for index derivative contracts should henceforth, be monitored by Market Infrastructure Institutions (MIIs) such as-

• Clearing corporations or stock exchanges on an intraday basis

• There should be an appropriate short-term fix, and a glide path for full implementation

• Currently, position limits for different categories of participants and products are specified by SEBI

• These are monitored at end of day by clearing corporations or stock exchanges

• Particularly on day of expiry of contract, there is a possibility of undetected intraday positions beyond permissible limits (End-of-day open positions are considered to be NIL)

4.Rationalisation of weekly index products

• Regulator has recommended providing weekly options contracts on single benchmark index of an exchange Presently- Weekly expiry index derivatives contracts are offered by stock exchanges in addition to monthly contracts

• There is an expiry of such weekly contracts on all five trading days of week across different indices/exchanges mirroring 0 DTE (Zero Day to Expiry) construct

• This results in speculative money moving from one expiry of index to another every single day

5.Removal of calendar spread benefit on expiry day

·SEBI has proposed –

Margin benefit for calendar spread positions would not be provided for positions involving any contract expiring on same day

6.Rationalisation of options strikes

• For rationalisation of options strikes, SEBI suggested-

• Strike interval be uniform up to fixed coverage of 4% near prevailing index price

• Interval increase as strikes move away from prevailing price (around 4 % to 8%)

• Not more than 50 strikes should be introduced for an index derivatives contract at time of contract launch

(Strike price of an option is price at which a put or call (buy or sell) option can be exercised)

7.Increase in margin near contract expiry

·SEBI has proposed – Increasing margins on expiry day and previous day to address issue of high implicit leverage in options contracts near expiry

• At start of day before expiry, Extreme Loss Margin (ELM) will be increased by 3%

• At start of expiry day, ELM will be further increased by 5%