MC Explains: New SEBI rules on trade in index-derivatives and how they are playing out

Before the SEBI directives, there were derivative contracts that were expiring every day of the week, which led to gambling like trading behaviour. (Photo by Jonathan Petersson: Pexels)

The market regulator’s (SEBI) new rules for trade in index derivatives have been the subject of much discussion recently.

Market participants, from small and big traders to brokers and exchanges, are quickly, though sometimes grudgingly, adjusting to the revised framework. Since there have been several circulars and updates on it, we have brought it all together as a ready reckoner.

Here are key points of the rules, and how they impact the traders and other market players.

From this date, exchanges were asked to have weekly expiry for derivative contracts of only one index.

Exchanges have weekly, monthly, quarterly and half-yearly expiries of index derivative contracts. Before the SEBI directive, every single day there was a weekly expiry.

This led to a lot of speculative trading because the market sees high volatility on these days and traders were taking bets on sharp price movements; for example, sell far out-of-the-money (OTM) options and buy another far OTM and hope to profit from the premium (price of the OTM option) at which they sold.

With the limit on weekly-expiry contracts, now NSE has weekly expiry only for Nifty contracts on Thursday and BSE for Sensex contracts on Friday. The weekly expiry of other contracts, which used to fall on Monday, Tuesday and Wednesday, have been done away with.

The last days of the weekly expiry contracts were as given below:

How will this affect traders? According to insiders, this will largely affect the revenues of brokerages, exchanges and government, who were earning from the trading volume (as brokerage, transaction fee and taxes). Zerodha's CEO Nithin Kamath had said that the brokerage expects a 30-50 percent drop in FY26 revenue from the implementation of this rule.

Traders who have been doing zero-days-to-expiry may simply need to change their strategy or leave the market, according to Ashish Gupta, a Singapore-based independent derivatives trader.

The two leading stock exchanges have informed that there will be a new set of expiry days for the index derivatives from January 1, 2025.

While there will be no change in expiry days for NIFTY monthly, weekly, quarterly and half yearly contracts, the NSE has informed that the expiry day of other contracts will change as follows:

BSE's new set of expiry days will fall on Tuesdays as shown below.

Option sellers are now being asked to pay an additional 2 percent extreme loss margin (ELM) on expiry day. This has been added because of the extreme speculative nature of trading, especially on expiry days, according to SEBI.

This would have to be paid by all option sellers at the start of the day and by those who are initiating a short position (option sellers) during the day.

According to market insiders, option buyers will face no impact from this but option sellers, even those who sell one lot for a margin of around Rs 1.5 lakh, could be affected. But the biggest hit will be on bigger option sellers, who work with capital anywhere above Rs 20 lakh, with their having to pay higher margins. Some like veteran trader Jitendra Jain expect a 30-50 percent hike when selling a popular strategy called the straddle or when selling out-of-the-money (OTM) options.

Jain also said that this could lead to a margin shortfall for traders who carry their one-day-to-expiry position overnight. The next day (on expiry day), they may find that they are short of the required margin when the additional ELM is charged. If it is a sharp move, they may find it hard to quickly meet the shortfall too.

Contracts will now need to have a minimum value of Rs 15 lakh.

Contracts of derivatives are not sold in ones or twos but in larger numbers which form what are called 'lots'. For example, Nifty50 used to have a lot size of 25; that is, a person has to buy a minimum of 25 contracts. These lot sizes have now been revised, from November 25.

This has been done to increase the value of the contracts, which is lot size multiplied by the underlying asset's value. According to market veterans, this will also  protect retail investors by discouraging those who do not have much capital from taking highly speculative trades.

While earlier contract sizes were valued between Rs 5 lakh and Rs 10 lakh, with the new rules the contract size should be a minimum of Rs 15 lakh at the time of the contract's launch and then revised to between Rs 15 lakh and Rs 20 lakh when lot sizes are reviewed.

According to insiders, this won’t affect a large majority of serious traders who anyway trade in quantities that are equivalent to the revised lot size. Smaller retail traders, who trade with a capital of Rs 1 lakh to Rs 2 lakh and who may be just experimenting with options, may find the higher costs discouraging and are likely to exit the market. Among these smaller traders, option buyers will need to pay a higher premium and option sellers a higher margin than they are comfortable with.

The regulator has asked brokers to collect premium (which is the price of an option) upfront from option buyers. This has anyway been the practice, according to market insiders, and therefore should not cause any big change in the market sentiment.

Then again, that the regulator had to specify it could mean that there were brokers who were allowing people to buy a contract without paying the whole cost. Market insider say that smaller brokers do allow this but there is no clear idea how widespread this practice is since this goes undetected.

Calender spread is when a trader buys (or sells) a contract of one expiry and sells (or buys) the same contract of a different expiry. That is buy a contract and sell the same, or sell a contract and buy the same for different expiry days. This used to reduce the margin requirement. But the regulator said that this should not be allowed anymore for contracts on expiry days. This is because the volatility and volumes on an expiry day is much higher than those of a future day. That is the risk of the one cannot be compared to the risk of the other, therefore the risk of one cannot be offset using the other as a hedge.

According to Gupta, this makes little sense because the move between the price of a contract on an expiry day and that of a contract that expires one month from now isn't very much. The margin collected for the expiry day should cover the risk well. However, according to him, if the regulator means to reduce participation in the expiry day trades by removing a way to reduce margin, then that reasoning would make more sense.

Another market insider said that there is another risk from a Calendar spread that uses a zero-days-to-expiration (0DTE) option. Traders sometimes buy an option that expires in a month and hedge it with an option that expires that very day (0DTE) option. Using such a hedge has two benefits: one, the 0DTE option can come very cheap and, two, the hedge reduces the margin the trader must pay. But when the 0DTE option expires, the trader does not buy another hedge to avoid the additional cost of the hedge. This means the trader and many such traders would be left holding a naked position and, if there is an extreme event on one day, the broker won’t be able to close the positions because the trader has not paid enough margin to cover the naked position.

That said, this rule may not have much impact because, according to market insiders, this isn't used very much by retail traders and won't lead to a drop in their participation or adversely affect market sentiment. This rule will largely contain the risk from an extreme event.

Position limits are caps set on the number of buy and sell contracts that can be created on an underlying asset. Stock brokers have been checking this at the end of a trading day to ensure that the limits are not breached.

The regulator has said that these checks need to be done more frequently on expiry days, i.e. four times during the day. Since there are huge volumes traded on expiry day, the regulator is concerned that these limits may be being breached during the course of the day and may go undetected because the check is done only at the end.

The regulator has put this in place out of concern over the heightened activity in index options, which is largely speculative in nature.

According to market insiders, small retail traders won't be impacted by this measure but those who bet on options in large quantities using proprietary accounts will need to exercise more caution. This may even put a dent on the illegal arrangement between some brokers who 'rent out' their prop book for a fee.