The special working committee set up by the markets watchdog Securities and Exchange Board of India (SEBI) in June on on futures and options to propose measures to curb the increasing play by retail traders in the derivatives market and also to reduce speculation, has suggested some sweeping changes to the index derivative framework. The committee recommended raising the minimum contract sizes by three to four times to Rs 20-30 lakh, and limiting fewer weekly expiries on options contracts on single benchmark index of an exchange among others.
Important among the recommendations was the substantial hike in the lot size to Rs 15-20 lakh in the first phase, and then Rs 20-30 lakh in the second phase and also collecting the margin money upfront from the trader on a daily basis.
In its consultation paper submitted to the SEBI on Tuesday, the committee also suggested collecting the options premium upfront and reducing the number of strike prices. These measures, believe the panel and the regulator, can help protect investors better and also help ensure market stability.
The SEBI expects these recommendations, if implemented, will help address excessive speculation driven by high retail participation in recent years.
Increasing the contract size by multiple times, the panel believes will make it harder for retail investors to participate in it or in a kind of “reverse sachetisation".
"Given the inherently higher risk in derivatives and the large amount of implicit leverage, increasing the minimum contract size would result in reverse sachetisation of such risk bearing products. So increase this to Rs 15-20 lakh in the first phase, and then Rs 20-30 lakh in the second phase,” says the paper.
The extant regulations allow index-based contracts to expire every day. The regulator now wants this to be limited to only weekly contracts per index per exchange. If finally allowed, there will be two expiries a week.
Also, currently, the minimum lot size required for the contract is Rs 5-10 lakh. This was set in 2019 but since the market volume has more than doubled to over Rs 500 trillion from a little over Rs 210 trillion in March 2018 and the share of the retail in index futures soared from around 2 percent to 41 percent as of March 2024.
In other words, for every Rs 100 traded by an individual investor in FY 2018, only Rs 2 went in to the index options segment, which has jumped to Rs 41 in FY24.
According to Sebi data, the overall derivatives turnover has soared from Rs 210 trillion in FY18 to Rs 500 trillion in FY24, while the futures and options (F&O) segment has seen growing retail investor participation, increasing by over 40 percent from 65 lakh in FY23 to 96 lakh in FY24. Individual participation in index options has also surged, rising from 2 percent in FY18 to 41 percent in FY24.
The current margin requirement is 100 percent and there is no explicit stipulation that option premiums or price of options have to be paid collected upfront. But now the paper suggests that the brokers collect the premium in entirety upfront, to make it difficult for the retail to have a larger play.
"Options prices depending on the moneyness move in a non-linear way and thus carry very high implicit leverage. These are timed contracts with possibility of very fast paced price appreciation as well as depreciation. To avoid any undue intraday leverage to end-client and to discourage any market wide practice of allowing position beyond the collateral at the end client level, it is desirable to mandate collection of options premium upfront from the buyer as against CCs blocking the collateral at CM level,” says the paper.
Calling for fewer strike prices, the paper says given the tendency of people to gamble on cheap options on faraway strike prices, it has suggested the following changes:
First, make the strike interval uniform near the prevailing index price (4 percent around prevailing price) and the interval to increase as the strikes move away from the prevailing price (4-8 percent). Secondly, limit the number of strikes to under 50 for an index derivatives contract at the time of the contract launch.
Thirdly, make it mandatory for new strikes to be introduced to comply with these aforesaid requirements on daily basis. Fourthly, exchanges must uniformly implement and operationalise the aforesaid principles after joint discussions.
The paper at the outset notes that while derivatives markets assist in better price discovery, help improve liquidity and allow investors to manage their risks better, the bursts of speculative hyperactivity in derivative markets, particularly by individual players, can detract from sustained capital formation by endangering both investor protection and market stability.
When NSE, which controls over 95 percent of the derivatives volume, thus becoming the world’s largest F&O exchange (controlling over 75 percent of the global volume) introduced the weekly options contracts in May 2016 on a sectoral index and launched weekly contracts in February 2019 on benchmark index, the expiry date of all such weekly contracts was on a single day of the week till 2022. But since BSE reintroduced weekly index derivatives contracts in May 2023, there has been shuffling by exchanges in terms of choosing expiry dates of the contracts to the extent that, as of now, there is expiry of weekly index derivatives contracts on all five trading days of the week.