Sebi margin rule on option sellers more bite than bark

This new measure increases by 2 percentage points the extreme loss margin (ELM) on the expiry day of index options on sellers, effectively increasing the margin to trade to 14% from 12% on index options expiry day. ELM is applied to cover risks beyond those envisaged by the standardized portfolio analysis of risk (SPAN) margin, which covers 99.9% of loss scenarios.

“The thinking initially was that the ELM increase would not have as significant an impact as compared to some of the other directives," said Ashish Nanda, president & head of digital business at Kotak Securities. “However, it so seems that those selling option contracts in index options on expiry day will see a reasonable rise in margins to trade."

Thanks to this new measure, quite a few clients received alerts from brokers on Tuesday night and Wednesday that they had margin shortfalls in their trading accounts, which needed to be topped up by Thursday, to enable them to hold on to their trades.

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This 2% increase in ELM by the Securities and Exchange Board of India (Sebi) was initially thought to be relatively insignificant compared to other rules brought in to reduce index option volumes. But when applied at contract level, the impact was seen to be far greater, and the quantum of shortfall in margins surprised some clients.

For instance, on a 23,500 put option on Nifty, the margin currently is 12% (10% SPAN plus 2% ELM). This will increase to 14% on expiry day, Thursday, which attracts more volumes than other days of the week. At contract level, the seller’s margin to trade will actually increase by 17%—from ₹70,500 (23,500 x 25 x 12%) to ₹82,250 (23,500 x 25 x 14%).

When one moves to lower levels or out-of-the-money puts, whose prices are below the underlying Nifty level of 23,500, the relative bump-up in margins will be even higher, explained Nanda.

He added that at-the-money (same level of Nifty/Sensex) and out-of-the-money index options (for a call level above Nifty/Sensex value and for a put below Nifty/Sensex) tended to see greater trading interest than in-the-money options—price lower than the underlying price for a call, and greater than the underlying price for a put.

Also read | Rising put option sales reflect market fears as supply of shares exceed demand

Brokers and proprietary traders said the impact will become visible more quickly than the contract size increases, which will kick-in in December and January next year. Sebi had said that status quo on contract size would apply to existing contracts and only new contract launches post 20 November would come with the increased size of 75 shares from 25 earlier for Nifty, and 20 shares from 10 earlier for Sensex.

“Two of three directives take immediate effect, one being the increase in ELM and the other, single index option expiries per exchange," said Rajesh Baheti, managing director of Crosseas Capital, a large jobbing and arbitraging firm.

“The cost to trade will rise as it’s on contract level and we will have to wait and gauge its impact after a few weeks," Baheti added. “Surely, business will be impacted and exchange volumes will take a hit of around 30% by the three measures alone."

Another broker said that if one had a margin of ₹100 and now he would need, say, ₹120, an option would be to sell deeper out-of-the-money options matching his margin or to stop trading, which would hit exchange volumes.

Also read | Index options trading swells to record high in Oct amid heightened uncertainty

The other Sebi measure stipulated that exchanges could launch just one weekly index option expiry against multiple weekly expiries prior to 20 November. This limits NSE to having just a weekly Nifty expiry against running weekly Bank Nifty, Midcap Select and Finnifty contracts, and BSE to a weekly Sensex expiry from running weekly Bankex expiry earlier.

Sebi’s measures

Sebi has stipulated six measures for curbing index option volumes, which are to be implemented in a staggered manner from 20 November. Three were to take effect from Wednesday, which was a market holiday for Maharashtra assembly elections.

Two others—removal of calendar spread benefit on expiry day, and upfront collection of premium from option buyers—from 1 February 2025. And intraday monitoring of position limits were to take effect from 1 April 2025.

The directives were spelt out by Sebi on 1 October after multiple studies by the regulator showed that nine out of 10 individual traders lost money trading in derivatives and that they continued trading despite the losses.