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

Sebi tightens F&O rules effective Nov 20, announces slew of measures

Market regulator Sebi has announced a slew of measures to strengthen index derivative framework to protect investors and improve market stability, including reducing expiries to a weekly basis. Each exchange will be allowed to provide derivatives contracts for only one of its benchmark index with weekly expiry.

The regulator has rolled out these measures after taking into consideration the highly speculative nature of trading on index derivatives, particularly on expiry day of the contracts.

The Securities and Exchange Board of India (Sebi) has also increased the minimum trading amount for derivatives from the present Rs 5-10 lakhs to Rs 15 lakh when it is introduced in the market, which will then be increased fall between Rs 15 lakh and Rs 20 lakh. As the press release by the market regulator said, "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 lakhs to Rs. 20 lakhs."

The new norms for derivative trading will be rolled out in phases, starting November 20. Index derivative contracts with weekly expiries, increase in contract sizes and and increase in tail risk coverage by levying additional extreme loss margin (ELM) will be launched from that day.

From February 1, 2025, there will upfront collection of option premium from buyers and removal of calendar spread treatment on  the expiry day. From April 1, 2025, there will be intraday monitoring of position limits.

Also read: Sebi easing compliance norms for RAs, IAs welcomed; some worry about bad actors flooding the scene

Daily expiries are out

The regulator noted that there expiry day trading in index options, when option premium are low, is largely speculative. Stock exchanges offer contracts that expiry every day of the week. The regulator's consultation paper has noted that there is hyperactive trading in index options on expiry day, with average position holding periods in minutes, accompanied by increased volatility in the value of the index through the day and at expiry.

Sebi said, "All this has implications for investor protection and market stability, with no discernable benefit towards sustained capital formation."

Therefore, the regulator has mandated that each exchange have derivative contracts only for one index in a week.

Higher contract size

The current contract sizes were set in 2015. Given how the market has changed and grown--with market value and prices having gone up 3x since--the regulator decided that it was time for another review in the interest of maintaining market stability and ensuring that participants are only taking appropriate risk.

Sebi's statement 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."

Higher margin requirement

ELM or extreme loss margin is collected from investors to cover extreme market events (tail risk). Since the regulator noted excessive speculative activity on expiry days, it has decided to ask for an additional 2 percent ELM to be collected from the investors.

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.

Upfront collection of premium

The regulator in October 2023 had mandated that brokers collect margins upfront. Now, taking into consideration how wildly the prices of options can move during the day, the regulator has asked the brokers to collect net option premiums (price) too upfront.  The statement from Sebi said, " In order to avoid any undue intraday leverage to the end-client, and to discourage any practice of allowing any positions beyond the collateral at the end-client level, it has been decided to mandate collection of options premium upfront from option buyers by the Trading Member (TM)/ Clearing Member (CM)."

Calendar-spread no more

The benefit of calendar spread--or offsetting positions across different expiries--will not be available for contracts that are expiring on that day. Sebi said that this has been decided after seeing that the value of a contract expiring on the day can move very differently from the value of similar contracts expiring in future.

The regulator's statement said, "Given the relatively very 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."

Intraday position limits

The position limits of index contracts are now captured on the end of every day. The regulator has asked stock exchanges and clearing corporations to now capture these position limits at least four times a day (this frequency can be increased according to the exchanges' or CC's convenience).

The press statement said, "amidst the large volumes of trading on expiry day, there is a possibility of undetected intraday positions beyond permissible limits during the course of the day."

It added, "To address the aforesaid risk of position creation beyond permissible limits, it has been decided that existing position limits for equity index derivatives shall henceforth also be monitored intra-day by exchanges. "