[Analysis] Proposed SEBI Amendments to Index Derivatives Market – Measures to Safeguard Investors

SEBI has introduced several regulatory measures to enhance the safety and stability of the derivatives market. These measures include increasing the minimum contract size for derivative contracts to between Rs 15 lakh to Rs 20 lakh in Phase 1 and Rs 20 lakh to Rs 30 lakh in Phase 2. Mandatory upfront collection of options premiums by trading members (TM/CM) is required to prevent undue intraday leverage. SEBI also proposes intraday monitoring index derivative positions to ensure compliance with position limits. The strike price intervals for options will also be rationalised, and margin benefits for calendar spread positions expiring on the same day will be eliminated. Weekly options contracts will be limited to a single benchmark index to reduce speculative trading, and increased margin requirements near options contract expiry will mitigate high implicit leverage risks. These measures aim to create a more secure and stable derivatives market, protecting retail investors and promoting economic benefits.

Table of Contents

1. Introduction
2. Increase in Minimum Contract Size for Derivative Contracts
3. Mandatory Upfront Collection of Options Premium by Members
4. Intraday Monitoring of Index Derivative Positions by Clearing Corporations/Stock Exchanges
5. Rationalisation of Strike Price for Options
6. Removal of Margin Benefit for Calendar Spread Positions on Contracts Expiring on the Same Day
7. Weekly Options Contracts to be Offered on a Single Benchmark Index for Enhanced Investor Protection
8. Increased Margin Near Options Contract Expiry to Mitigate High Implicit Leverage Risks
9. Conclusion

1. Introduction

SEBI, the securities market regulator in India, has raised concerns over households incurring annual losses of up to Rs. 60,000 crore in the futures and options (F&O) market. Such substantial financial losses could alternatively be channelled into IPOs, mutual funds, or other economically beneficial investments. Notably, retail investors constitute 50% of index derivatives’ trading volumes, frequently resulting in considerable losses. In the financial year 2024 alone, approximately 92.5 lakh individuals and entities experienced collective losses amounting to Rs. 51,689 crore in NSE index derivatives trading.

Research indicates that 90% of F&O trades culminate in losses for individual traders, whereas high-frequency traders and foreign portfolio investors generally accrue profits. The trading turnover for index options has surged dramatically, from ₹4.5 lakh crore in 2018 to ₹140 lakh crore in 2024, with net trading losses surpassing 32% of the net inflows into mutual funds’ Growth and Equity schemes during FY24.

SEBI has put forward a series of regulatory measures to curb excessive speculative trading and safeguard individual investors. These measures include increasing the minimum value of derivative contracts, mandating the upfront collection of options premiums, implementing intraday monitoring of position limits, adjusting strike prices for options, eliminating margin benefits for calendar spreads on the same day, and restricting weekly options contracts to only one benchmark index. These initiatives are designed to foster a more secure and stable derivatives market that benefits investors and the broader economy. The specifics of these proposals are elaborated upon in the subsequent sections:

2. Increase in Minimum Contract Size for Derivative Contracts

Currently set in 2015, the minimum contract size for derivative contracts ranges between Rs 5 lakh to Rs 10 lakh. Since then, benchmark indices have tripled. SEBI now proposes that the initial minimum value of derivative contracts be set between Rs 15 lakh to Rs 20 lakh in Phase 1. Following a period of six months in Phase 2, this value would escalate to between Rs 20 lakh to Rs 30 lakh.

3. Mandatory Upfront Collection of Options Premium by Members

Presently, there is no definitive rule mandating the upfront collection of options premiums by members from buyers. To prevent undue intraday leverage and discourage the practice of allowing positions beyond the collateral at the client level, SEBI plans to enforce the upfront payment of options premiums by TM/CM from the options buyers.

4. Intraday Monitoring of Index Derivative Positions by Clearing Corporations/Stock Exchanges

SEBI sets position limits for various participants and product types, monitored by Market Infrastructure Institutions (MIIs) such as Clearing Corporations and Stock Exchanges at the close of each trading day. Particularly on expiry days, positions that exceed permissible limits intraday may go undetected, as positions at the end of the day will show as NIL. To address this, SEBI proposes that position limits for index derivative contracts should also be monitored intraday by the clearing corporations and stock exchanges. This would include an appropriate short-term solution and a gradual implementation plan.

5. Rationalisation of Strike Price for Options

Currently, exchanges introduce options strikes at uniform price intervals based on the prevailing index value, covering approximately 7% to 8% of index movement. For contracts with shorter tenures, this results in a wide dispersion of trading activity across numerous strikes, which can trigger abrupt price movements in these options. To streamline this, SEBI suggests a revision of the strike price[1] introduction method:

• Uniform strike intervals near the current index price should be maintained at about 4%, widening to 4% to 8% as the strikes diverge from the prevailing price.
• A limit of no more than 50 strikes should be introduced at the launch of any index derivatives contract.
• New strikes should be introduced daily.
• Exchanges should uniformly implement and operationalise these principles following a collective discussion.

6. Removal of Margin Benefit for Calendar Spread Positions on Contracts Expiring on the Same Day

The margin requirements for futures and options positions typically decrease when offset by a position with a future expiry date, due to the application of calendar spread margins instead of the standard margins for two separate positions. However, due to the volume concentration and risks associated with expiry days, SEBI proposes that the margin benefits for calendar spreads involving contracts expiring on the same day should be eliminated.

7. Weekly Options Contracts to be Offered on a Single Benchmark Index for Enhanced Investor Protection

Stock exchanges currently offer weekly expiry index derivative contracts across various indices, which expire on every trading day of the week. This leads to speculative capital shifting frequently between indices. To improve investor protection and market stability, SEBI recommends that weekly options contracts should only be offered on a single benchmark index of an exchange.

8. Increased Margin Near Options Contract Expiry to Mitigate High Implicit Leverage Risks

To mitigate the risks associated with high implicit leverage near the expiry of options contracts, SEBI proposes increased margin requirements:

• The Extreme Loss Margin (ELM) should be raised by 3% at the beginning of the day before expiry.
• On the expiry day itself, the ELM should increase by an additional 5%.

9. Conclusion

In conclusion, the measures proposed by SEBI aim to enhance the safety and stability of the derivatives market. These include increasing the contract size, requiring upfront collection of options premiums by members, and curbing excessive speculative activity. Such initiatives are designed to fortify the derivatives market, making it more secure, transparent, and efficient in India, thereby safeguarding the economy and household savings.

[1] Strike price is the predetermined price at which a call or put option contract can be traded on or before the pre-decided expiry date