The Securities and Exchange Board of India (SEBI) has recently released a consultation paper, sparking widespread discussion within the financial sector. This paper addresses the significant concerns surrounding derivatives trading in India, particularly the alarming loss of household savings in this segment. With retail investors contributing to nearly half of the trading volumes in index derivatives, the impact of these losses on the broader economy is undeniable. SEBI’s proposed changes aim to bring more stability and transparency to the market while protecting retail investors. This blog explores the key changes proposed by SEBI and their implications.
Alarming Losses in Derivatives Trading
In the fiscal year 2023-24, the derivatives trading segment witnessed a staggering loss of Rs 51,689 crore among 92.50 lakh unique individuals and proprietorship firms trading on the NSE. With approximately 85% of these investors incurring losses, the situation has raised concerns about the sustainability of household savings in the market. SEBI has noted that these funds could be more productively allocated towards IPOs, mutual funds, or other avenues that contribute to the growth of the Indian economy.
7 SEBI’s Proposed Changes
- Number of Strike Prices for Options
- Existing: Currently, Nifty offers up to 70 option strikes, while BankNifty has around 90 strikes, with intervals uniformly spread.
- Proposed: SEBI suggests reducing the number of strikes to a maximum of 50 for indices, with intervals increasing as they move away from the prevailing price.
- Rationale: The aim is to curb speculative trading where investors buy far out-of-the-money (OTM) options, hoping for a zero-to-hero trade outcome.
- Upfront Collection of Options Premium
- Existing: Margins are collected for futures positions and short options, but there is no requirement for upfront premium collection from options buyers.
- Proposed: SEBI is considering the collection of options premiums from buyers upfront, although the specifics are still being clarified.
- Removal of Calendar Spread Benefit on Expiry Day
- Existing: Currently, a calendar spread margin is applied even on the expiry day for F&O positions with different expiries.
- Proposed: The proposal seeks to eliminate calendar spread margins for contracts expiring on the same day.
- Rationale: This change aims to prevent the carry-forward of positions into the next expiry, as the market direction could change and liquidity could be less.
- Intraday Monitoring of Position Limits
- Existing: Position limits are currently monitored at the end of each trading day.
- Proposed: SEBI plans to implement real-time, intraday monitoring of position limits for index derivatives.
- Rationale: This change will ensure that traders do not exceed their limits due to market fluctuations.
- Minimum Contract Size
- Existing: The current minimum contract size is between Rs 5 – Rs 10 lakh.
- Proposed: SEBI proposes to increase the minimum contract size to Rs 15 – Rs 20 lakh in Phase 1, and Rs 20 – Rs 30 lakh in Phase 2.
- Impact: This change will significantly increase the lot sizes, potentially removing smaller retail traders with limited capital from the market.
- Rationalisation of Weekly Index Products
- Existing: Currently, weekly expiries occur for different indices, leading to expiries on every trading day of the week.
- Proposed: SEBI suggests limiting weekly expiries to one benchmark index per exchange.
- Rationale: This measure is intended to reduce speculative trading and the associated large volumes on a daily basis.
- Increase in Margin Near Contract Expiry
- Existing: No additional margin is required during the last two trading days of a contract’s expiry.
- Proposed: SEBI plans to introduce an additional Extreme Loss Margin (ELM) of 3% on the penultimate day and 5% on the final day of the contract expiry.
- Rationale: This increase is designed to buffer against the heightened risk and volatility often seen as contracts near expiry.
Conclusion
SEBI’s proposed changes reflect a proactive approach to addressing the systemic risks posed by the current derivatives trading environment. By tightening regulations and introducing measures to curb excessive speculation, SEBI aims to safeguard retail investors and redirect capital towards more productive uses within the economy. As the consultation period progresses, it will be crucial for stakeholders to provide their feedback, ensuring that the final regulations strike a balance between market efficiency and investor protection. With the deadline for comments set for August 20, 2024, the financial community eagerly awaits the next steps in this critical regulatory process.
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