Expiry day trading frenzy threatens market stability: SEBI's Ananth Narayan

Singh also noted that their supervision strategy is changing. "We want to reduce blind spots in markets. Blind spots can become very big and cause harm. Can we reduce these blind spots with technology, with closer supervision with tech. This is an area where we are focussing a lot on," he said.

SEBI's Whole Time Member Ananth Narayan highlighted concerns about the frenzied options trading closer to expiry dates and its possible impact on market stability and vulnerability to manipulation. Speaking at FICCI's 21st Capital Market Conference in Mumbai on August 2, Narayan stressed the need for a balanced approach that supports both a healthy derivative market and investor protection.

"The frenzied trading on expiry day raises questions on market stability and vulnerability to manipulation," Narayan said. He emphasised the importance of not eliminating the benefits of options trading while managing the trading frenzy. "We must not throw the baby out with the bathwater," he noted, though currently, it is difficult to "see any baby in the water at all."

The regulator's current focus is on reducing the systemic frenzy associated with expiry day trading. Narayan mentioned that five out of the seven proposals in the July 30 consultation paper address this issue. The sixth proposal aims to increase lot sizes to align with global markets, and the seventh proposal requires brokers to collect option premiums, which Narayan described as "a matter of basic hygiene."

Derivatives trading in India has surged exponentially since the pandemic, with nearly 80 percent of currently active demat accounts opened after April 2020. This rapid growth has positioned the Indian derivatives market as a global leader, accounting for 30 to 50 percent of global exchange-traded derivatives trading. However, regulators have flagged potential risks arising from this proliferation.

SEBI's recent consultation paper aims to protect investors and ensure market stability by addressing the surge in expiry-day punts. A significant portion of the recent growth in Indian derivatives has come from index option contracts. SEBI's data on volatility, notional and premium turnover indicate that expiry-day trading has been the primary driver of increased activity in index options.

The high volume-to-open interest (OI) ratio in the final minutes before expiry suggests that participants are engaging in speculative trades, often concentrated in strike prices far from the prevailing index levels. These speculative strategies in deep out-of-the-money (OTM) options on expiry days, commonly referred to as Zero-to-Hero strategies, resemble gambling due to their low probability of success but low entry cost, making them popular among new traders with a speculative mindset.

To address the issue of high implicit leverage in options contracts near expiry, SEBI has proposed increasing the Extreme Loss Margin (ELM) by three percent to five percent. Much of the activity is concentrated in expiry-day contracts, particularly in those with strike prices significantly away from prevailing market levels, available for a low premium.

SEBI's recent study revealed that 92.5 lakh retail traders and proprietorship firms incurred a trading loss of Rs 51,689 crore in FY24. Out of these, only 14.22 lakh investors made a net profit, indicating that approximately 85 out of 100 traders incurred a net trading loss.

The SEBI consultation paper seeks to strengthen the index derivatives (futures & options) framework for increased investor protection and market stability. The proposed measures aim to enhance investor protection, promote market stability in derivatives markets, and ensure sustained capital formation.