Leading global traders resist Sebi’s plan to measure risk in derivatives, raise ‘price manipulation’ fears

Sebi issued a discussion paper on tweaks to F&O market in February

Capital market regulator Sebi’s plans to reduce volatility in the derivatives segment is facing opposition from a leading global trading body that represents the likes of Jane Street and Citadel, raising concerns over market liquidity and even ‘price manipulation’ in its feedback.

In response to Sebi’s consultation paper on derivatives market dated February 24, prominent global trader lobby group Futures Industry Association (FIA) has said that the new measures would dampen liquidity and increase trading costs while increasing operational complexity. In a letter dated March 13, FIA argued the proposed changes could create market inefficiencies that may ‘inadvertently increase the likelihood of price manipulation’.

FIA is a global lobby group that represents interests of large foreign trading firms such as Citadel, IMC Financial Markets and Jane Street Capital.

Sebi had proposed to tweak norms to discourage traders from buying deep out of money options or futures contracts. In a discussion paper floated on February 24, Sebi proposed to change the methodology for calculation open interest (OI) by introducing delta-based limits, an important tweak, as OI is crucial to determine market-wide position limits (MWPL).

Moneycontrol had written on January 15 that the regulator was considering this move.

“As currently structured, these measures could dampen market liquidity, increase trading costs, and introduce operational complexities. They may lead to wider bid-ask spreads, heightened market volatility, and reduced participation from institutional investors, ultimately impacting market depth and efficiency,” FIA said in its letter to Sebi dated March 13.

“Implementing delta-adjusted thresholds require multiple layers of calculation, monitoring and dissemination across the trading ecosystem, adding operational burdens and increasing the risk of errors,” FIA said.

For each stock, MWPL is 20% of the market capitalization of the stock or 30 times the average daily traded turnover, whichever is lower. When the open interest in a stock reaches 95% of MWPL, the stock goes into F&O ban until OI falls below 80%.

Currently, open interest is a sum of outstanding contracts in futures and options of a particular stock, but Sebi’s consultation paper has proposed a weightage-based approach in calculating open interest. For options, Delta will range between 0 to +1, while for futures it will be +1. For long calls and short puts, the Delta will range from 0 to -1.

In the options segment, the contracts closer to the strike price get weightage near +1, while contracts that are farthest out of money from strike price get a weightage of 0.

Though FIA has supported the intent of Sebi to curb excess volatility in the derivatives segment, it has pointed out that none of the global markets use such delta-based system.

“…the Gross Delta limit aims to enhance risk management, it may not fully achieve its intended objective. An entity could still take large positions in short-term out-of-the-money (OTM) options with low Net and Gross Delta but high Gamma, causing rapid fluctuations in FutEq (Future Equivalent) Delta as the market moves. This could introduce risks that a Gross Delta limit alone may not effectively address,” FIA said.

Gamma risk is a secondary risk, calculated as the rate of change between an option's Delta and price of the underlying asset.

In the February 24 discussion paper, Sebi argued that the current notional way of calculating open interest did not capture accurate picture of the market activity, and could be potentially used for manipulation.

“A key objective of moving to a Future Equivalent (FutEq) or Delta-based OI is to address the limitations of notional-based OI, particularly its lack of meaningful aggregation across futures and options. Under a purely notional approach, there is potential for manipulation, such as artificially pushing a scrip into the ban period or obscuring the true risk exposure of certain positions,” the global trader lobby group has said.