SEBI’s new F&O framework could curb retail participation, but experts question impact on reducing losses

SEBI said that starting November 20, each exchange would be allowed to provide derivatives contracts with weekly expiry for only one of its benchmark indices

Market participants believe that the new regulatory framework for equity derivatives put in place by the Securities and Exchange Board of India (SEBI) will strengthen the segment but are sceptical of whether the norms would help mitigate the retail losses in the options arena.

Among a slew of changes announced on Monday, the capital markets watchdog said that starting November 20, each exchange would be allowed to provide derivatives contracts with weekly expiry for only one of its benchmark indices.

Incidentally, the expiry day is often the most profitable day for an options trader as the value of an option can multiply up to 10x if the market moves in the predicted direction. Previously, with every day expiries, a trader with Rs 50,000 could place a bet worth Rs 10,000 each day. Assuming the market did not move in the expected direction, the losses would be spread out over a week’s duration.

However, with a shift to one expiry a week the same trader could potentially lose the entire Rs 50,000 in a single day as a trader can always bet higher amount in anticipation of higher profits.

“While the overall loss remains the same, the key difference is that it could happen all at once instead of being spread out over multiple days,” said Saketh Ramakrishna, founder of Quick Algo.

Another measure announced was increasing the minimum contract size for index derivatives from the current Rs 5-10 lakh to Rs 15-20 lakh. This, according to market participants, is expected to take option sellers with less money to look at option buying as that can be done with a lesser quantum of funds.

“An option trader will not move out from the market just because the lot size has increased, a seller with lesser capital might move to buying, and option buyer with lesser capital will end up buying a lower premium option" said Saketh. He said that this framework might push people to trade a riskier way which can eventually increase the loss.

In a similar context, Raghav Mallik, founder & CEO of Algo Test, said that such a regulation will push out the profitable option sellers from the market. With this, Sebi's analysis that 89 percent of traders lose money in derivatives may shoot up, he added.

While the regulator's aim is to protect investors, stricter norms around leverage, transparency, and capital adequacy could limit the ability of investors to determine their own risk appetite, thereby stifling innovation in trading strategies, said Puneet Sharma, CEO and Fund Manager at Whitespace Alpha.

“By putting guardrails around the market, Sebi may inadvertently reduce participation from those investors who could have otherwise contributed significantly to the evolution and liquidity of the market,” said Sharma.

He added that over-regulation in an environment that thrives on strategic flexibility could dampen the market’s dynamism, affecting India's competitiveness in the global derivatives landscape.

Meanwhile, brokerages who have a high share of revenue coming from derivatives, mostly discount brokers, will face the heat, said Kranthi Bathini of Wealthmills Securities. He added that the impact of the new rules will be lesser for brokers who have a healthy mix of cash and derivatives volume.