SEBI’s F&O rules may curb volatility in indices, trim retail trading; large traders may adjust strategies

SEBI's latest measures strengthening the index derivatives framework are designed to protect retail investors and traders from highly speculative derivatives trading.

SEBI's new rules on Futures & Options trading effective November may lead to trimming of volatility in the underlying indices with less frequent expiries, while stricter margin requirement and bigger lot sizes may drive some retail traders away to cash trading.

Experts said that it could have a stabilising effect on the markets in the long term after unwinding of the current positions in October. Large traders are expected to adjust to new rules with relative ease in the time allowed for migration to new rules.

However, the backdrop of rising tensions from the Israel-Iran conflict continues to add uncertainty and weigh heavily on investor sentiment.

The Securities and Exchange Board of India (SEBI) announced several measures this week aimed at strengthening the framework for index derivatives, including increasing contract sizes and limiting expiry days to one per week for each exchange.

The rules are designed to protect investors -- especially retail traders -- from highly speculative derivatives trading, particularly on expiry days, which has historically led to increased volatility in the markets.

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Sudeep Shah, Head of Technical and Derivative Research, SBI Securities, said that the increase in lot sizes from Rs 5-10 lakhs to Rs 15 lakhs is intended to create a barrier to entry for inexperienced retail traders, which could mitigate their financial risks.

He said this shift may encourage a retail traders' transition from F&O trading to equity trading, or even towards MTF trading products (margin trading facility), which also offers leverage.

Further, Shah said that limiting each exchange to one weekly expiry per index could significantly reduce the excessive trading seen on expiry days, potentially leading to lower volatility in the underlying indices.

Rajesh Palviya, Senior Vice President, Axis Securities said that while the cost of trading may rise due to larger lot sizes and increased margin requirements, the overall market dynamics are not expected to change significantly. He added that as for indices, traders already trade in short term set-ups, from expiry-to-expiry, whether monthly or weekly. They could quickly adapt their strategies to comply with the new rules.

Also read | SEBI tightens F&O rules effective Nov 20, announces slew of measures; daily expiries to go, contract sizes to triple

However, Palviya also said that the rising cost of trades may prompt high-frequency traders to rejig their strategies. Also, as some of the rules such as increased margin and bigger lot sizes may drive away small retail traders, this could also lead to high frequency traders trimming their positions since they would have difficulty finding enough retail traders to take the counter trade.

Meanwhile, Ruchit Jain from 5paisa.com said that large traders, who are familiar with the cost structures associated with trading, are likely to adapt without significant issues. He noted that higher lot sizes would not pose a challenge for them, as they can maintain the necessary margins.

As the market absorbs SEBI’s regulatory changes, it’s the ongoing Israel-Iran conflict which remains a major concern, alongwith the short build up in headline indices derivatives, and weakening technical setup.

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