New SEBI rules to curb F&O frenzy

03-10-2024

On 2nd October, The Securities and Exchange Board of India (SEBI) introduced 6 new measures aimed at regulating the equity index derivatives market, commonly known as futures and options (F&O).

These regulations come in response to a significant increase in trading volumes, which has raised concerns about retail investor losses and systemic risks to the economy.

Key Measures Implemented by SEBI:

Recalibration of Contract Size
1. New Minimum Contract Size: The minimum contract size for index derivatives has been raised from ₹5-10 lakh to ₹15 lakh.
2. Rationale: This adjustment aims to ensure that participants take on appropriate risks and curtail speculative trading, particularly among small investors.
3. Implication: This could reduce hyperactivity among small traders. Retail investors, especially from tier 2 and tier 3 cities, may need to rethink their strategies, potentially leading them to avoid high-risk index derivatives.
Upfront Collection of Options Premium
1. New Requirement: SEBI has mandated the upfront collection of options premiums from buyers, effective February 1, 2025.
2. Purpose: This measure is designed to limit excessive intraday leverage and ensure prudent risk management at the investor level.
3. Implication: This will help to mitigate the risks associated with over-leveraged positions, reducing aggressive speculation.
Rationalization of Weekly Index Derivative Products
1. Limit on Expiry Products: SEBI has directed that each exchange can only provide weekly expiry contracts for one benchmark index, effective November 20, 2024.
2. Objective: This is intended to reduce speculative trading associated with multiple short-tenure options contracts that expire weekly.
3. Implication: By limiting these products, the regulation aims to decrease market volatility, particularly on expiry days, and reduce naked options selling.
Intra-day Monitoring of Position Limits
1. New Compliance Measure: Effective April 1, 2025, SEBI will require intra-day monitoring of position limits for equity index derivatives.
2. Goal: This measure aims to detect and address excessive trading activity in real-time, not just at the end of the day.
3. Implication: This proactive approach will help maintain orderly market behavior and prevent speculative excesses throughout the trading day.
Removal of ‘Calendar Spread’ Treatment on Expiry Day
1. Change in Treatment: Starting February 1, 2025, the benefit of offsetting positions (calendar spread) across different expiries will not apply on the day of expiry.
2. Reasoning: This is designed to address the significant basis risk that can arise on expiry days, where contract values may fluctuate unpredictably.
3. Implication: This will compel traders to roll over their positions earlier, reducing speculative behavior and stabilizing pricing.
Increased ‘Tail Risk’ Coverage on Expiry Day
1. New Margin Requirement: An additional Extreme Loss Margin (ELM) of 2% for short options contracts will be imposed to cover tail risks, effective immediately.
2. Purpose: This aims to protect against unexpected market movements, particularly on volatile expiry days.
3. Implication: This measure will encourage greater accountability among market participants and act as a protective buffer against sudden market downturns.

SEBI - Securities and Exchange Board of India

What is SEBI?

SEBI, established on April 12, 1992, is the regulator for India’s securities market. It aims to ensure transparency and protect investors.
SEBI is headquartered in Mumbai and has regional offices in New Delhi, Ahmedabad, Kolkata, and Chennai.

History of SEBI:

Before SEBI, the securities market was managed by various agencies, causing inconsistencies.
In 2014, SEBI gained more powers, including conducting search and seizure operations and enforcing stricter penalties. It is now a leading global regulatory authority.

Objectives of SEBI:

SEBI's main goals are to regulate India's securities market, safeguard investors' interests, ensure a safe investment environment, and prevent market malpractices.

Organizational Structure:

SEBI has a corporate structure with over 20 departments. It is managed by a Board of Directors, which includes:

The Chairman (nominated by the Indian government)
Two members from the Union Finance Ministry
One member from the Reserve Bank of India (RBI)
Five other members nominated by the Union Government

Key departments include:

Information Technology
Foreign Portfolio Investors
Office of International Affairs
National Institute of Securities Market
Investment Management
Commodity and Derivative Market Regulation
Human Resource

Functions of SEBI:

SEBI's functions include:

Protecting investor interests
Promoting market development
Regulating securities market operations
Serving as a platform for market professionals
Educating investors
Preventing fraudulent practices
Monitoring company takeovers and share acquisitions

Powers of SEBI:

SEBI's powers include:

Quasi-judicial: Making judgments in cases of market fraud and unethical practices.
Quasi-executive: Inspecting documents and taking legal actions against violators.
Quasi-legislative: Formulating rules and regulations for market practices, including insider trading and disclosure requirements.

The Supreme Court of India and the Securities Appellate Tribunal oversee SEBI’s functions.

Conclusion

SEBI's new measures to regulate the F&O segment are focused on protecting small investors, reducing speculation, and improving overall market stability. By increasing contract sizes, mandating upfront premium collections, and introducing intra-day monitoring, the regulator aims to foster a healthier trading environment that mitigates risks associated with excessive leverage and speculative trading. These changes are expected to significantly impact how retail investors participate in the derivatives market, ultimately contributing to more stable capital formation and economic growth.