F&O trading: Sebi proposes upfront collection of options premium, increase in contract size, margin

Market regulator Sebi on Tuesday floated consultation paper on seven near-term measures in the index derivatives segment aimed at curbing market speculation, enhancing investor protection and ensuring market stability. They include collection of option premiums on an upfront basis, revision in minimum contract size, rationalisation of weekly index products, intraday monitoring of position limits, rationalisation of strike prices, removal of calendar spread benefit on expiry day and increase in near contract expiry margin, among others.  

The proposals are made in the light of increased retail participation, offering of short-tenure index options contracts and  heightened speculative trading volumes in index derivatives on expiry days. 

Upfront collection of options premium
Sebi has proposed that members may collect option premiums on an upfront basis from the clients. At present, 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.

Minimium contract size
Sebi proposed to revise the  minimum contract size for index derivative contracts under two phases. In the Phase 1, the interval for the minimum value of derivatives contract is proposed to be revised to Rs 15-Rs 20 lakh. After six months, this minimum value can be raised to Rs 20-30 lakhs.

At present, the minimum contract size requirement for derivative contracts is Rs 5-10 lakhs, which was last set in 2015. During the last nine years, the benchmark indices have gone up by nearly three times. The increase in minimum contract size would result in reverse sachetization of such risk bearing products.

Intraday monitoring of position limits
Given the evolving market structure, the position limits for index derivative contracts should be monitored by the clearing corporations/ stock exchanges on intra-day basis, with an appropriate short-term fix, and a glide path for full implementation, given the need for corresponding technology changes, Sebi proposed.  

Increase in margin near contract expiry
To address the issue of high implicit leverage in options contracts near expiry, creating a high risk on notional basis for entities dealing in options, the margins on expiry day and the day before expiry is proposed to be increased. At the start of the day before expiry, Extreme Loss Margin (ELM) is proposed to be increased by 3 per cent while at the start of expiry day, ELM is proposed to be further increased by 5 per cent.

Weekly index products
To enhance investor protection and promote market stability in derivative markets, weekly options contracts to be provided on single benchmark index of an exchange, Sebi proposed.

The markets regulator noted that the Indian market ecosystem continues to build in conservative safety buffers in terms of margins and default management waterfalls but the daily expiry of options contracts on different indices combined with unusual nature of hyperactivity around expiry does pause significant risk to market stability. 

Strike price rationalisation for options
Sebi said the existing strike price introduction methodology may be rationalised, adding strike interval can be uniform near prevailing index price (4 per cent around prevailing price) and the proposed interval to increase as the strikes move away from prevailing price (around 4 per cent to 8 per cent). It proposed not more than 50 strikes to be introduced for an index derivatives contract at the time of contract launch. New strikes are proposed to be introduced to comply with aforesaid
requirement (on daily basis. Sebi proposed stock exchanges to uniformly implement and operationalise the aforesaid principles after joint discussion. 

Removal of calendar spread benefit

The margin benefit for calendar spread positions would not be provided for positions involving any of the contracts expiring on the same day, Sebi proposed. To be sure, the margin requirement for an F&O position reduces significantly by offsetting position on a future expiry as calendar spread margin applies on such position instead of normal margin on two positions. While there is a valid reason for aforesaid margin benefit, expiry day can see significant basis risk where the derivative value for the contract expiring can move very differently from the derivative value on away month expiry, Sebi said.

Sebi had formed an Expert Working Group  (EWG) to  examine  the  matter. The immediate  near  term recommendations of EWG were deliberated by the Secondary Market Advisory Committee (SMAC) of SEBI, pursuant  to  which Sebi made the proposals.