Sebi floats new guidelines for high-risk derivative trading, implementation in phased manner

The Securities and Exchange Board of India (SEBI) has brought in a new set of guidelines in a bid to regulate high-risk futures and options (F&O). On Tuesday, the market regulator said it will be implementing guidelines ranging from increasing the contract size to Rs 15 lakh from Rs 5-10 lakh to limit weekly expiries to one per exchange. 

As per the latest F&O rules, the derivative contract value cannot be less than Rs 15 lakh. "All other stipulations for contract size of index derivatives as mentioned in the Master Circular referred above shall remain unchanged... The measure shall be effective for all new index derivatives contracts introduced after November 20, 2024," SEBI said in its notification.

The implementation of updated guidelines for derivative trading will occur in multiple stages, commencing on November 20 and is based on suggestions by an Expert Working Group (EWG) to strengthen the equity index derivatives framework.

From November 20, new features such as index derivative contracts with weekly expiries, larger contract sizes, and enhanced protection against tail risks through the imposition of additional Extreme Loss Margin (ELM) will be introduced.

Top points

1. Upfront collection of Option premium: February 2025

Options prices move in a non-linear way and carry very high implicit leverage. "In order to provide sufficient time to implement the aforesaid measure, this requirement would be applicable for equity derivatives segment from February 01, 2025," SEBI said in a circular.

2. Removal of calendar spread treatment on expiry day: February 2025

Given the relatively large volumes witnessed on the expiry day vis-à-vis future expiry days, and the enhanced basis risk that it represents, it has been decided that the benefit of offsetting positions across different expiries ('calendar spread') shall not be available on the day of expiry for contracts expiring on that day.

"This would also align calendar spread treatment with a cross-margin framework on correlated indices having different expiries, wherein such cross-margin benefit is fully revoked at the start of the first of the expiring correlated indices," Sebi said.

3. Intraday monitoring of position limits: April 1, 2025

Sebi had instructed stock exchanges to monitor existing position limits for equity index derivatives as there is a risk of positions being created beyond permissible limits amid huge volumes on expiry day.

"For this purpose, stock exchanges shall consider minimum 4 position snapshots during the day. The number of snapshots may be decided by the respective stock exchanges subject to a minimum of 4 snapshots in a day," the regulator said.

To provide sufficient time for implementation, the measure shall be effective for equity index derivatives contracts from April 1, 2025.

4. Contract size for index derivatives: November 2024

With effect from November 20, 2024, Sebi has increased the minimum contract size for index futures and options from Rs 5-10 lakh currently to Rs 15 lakh at the time of its introduction in the market.

Further, the lot size shall be fixed in such a manner that the contract value of the derivative on the day of review is within Rs 15 lakh to Rs 20 lakh, the regulator said.

"Given the inherent leverage and higher risk in derivatives, this recalibration in minimum contract size, in tune with the growth of the market, would ensure that an inbuilt suitability and appropriateness criteria for participants is maintained as intended," Sebi said.

5. Limiting weekly index expiry to one per exchange: November 20

Dalal Street will get rid of the one-expiry-a-day phenomenon, which has been blamed for increasing the speculative activity in the market.

To solve the problem of excessive trading in index derivatives on expiry day, it has been decided to rationalise index derivatives products offered by exchanges which expire on a weekly basis. With effect from November 20, 2024, weekly derivatives contracts would only be available on one benchmark index for each exchange.

This means that BSE and NSE will have to choose one index derivative product each for weekly expiry contracts.

6. Increase in tail risk coverage

Given the heightened speculative activity around options positions and the attendant risks, Sebi has decided to increase the tail risk coverage by levying an additional ELM (extreme loss margin) of 2% for short options contracts.

This would be applicable for all open short options at the start of the day, as well on short options contracts initiated during the day that are due for expiry on that day. For instance, if weekly expiry on an index contract is on 7th of the month and other weekly/monthly expiries on the index are on 14th, 21st and 28th then, for all the options contracts expiring on 7th, there would be an additional ELM of 2% on 7th.

Sebi report

Based on a recent study by Sebi, individual traders in India experienced net losses amounting to Rs 1.81 lakh crore in futures and options trading from April 2021 to March 2024, with only 7.2% managing to make a profit.

In the same timeframe, retail investors incurred gross losses of Rs 524 billion, while proprietary traders representing financial institutions and foreign investors achieved gross profits of Rs 330 billion and Rs 280 billion, respectively, for the 12 months leading up to March 30, 2024.

The report highlighted a significant statistic indicating that between FY22-24, approximately 1.13 crore individual traders suffered a collective loss of Rs 1.81 lakh crore in F&O trading. This analysis was based on data collected from 15 brokers, representing 90 per cent of total individuals in FY24.

It is notable that 93 per cent of individual traders in this sector experienced financial losses. Each loss incurred in F&O trading results in gains for a counter-party, which, in this instance, were Foreign Portfolio Investors (FPIs) and proprietary traders. This transfer of wealth amounted to approximately $22 billion, predominantly from the bank accounts of middle-class Indian traders to a select few sophisticated FII pod shops like Jane Street and Millennium Capital, along with proprietary traders and brokerages (inclusive of transaction costs).