SEBI cracks down on F&O trading mess, suggests contract size to strike price for retail investors; 7 key measures

Capital markets regulator Securities and Exchange Board of India (SEBI) has proposed a series of near-term measures to prevent speculative trading, such as gambling in index derivatives, which include curbing multiple option contract expiries and increasing the size of options contracts. The seven measures suggested by the market watchdog are aimed at curbing market speculation, enhancing investor protection and ensuring greater market stability.

Indian markets have often flagged risks from retail investors' speculative trading in derivatives. SEBI's proposals are made in light of increased retail participation, offering short-tenure index options contracts, and heightened speculative trading volumes in the index derivatives on expiry days.

Also Read: F&O trading: Sebi to discuss ways to tighten the screws on retail speculation

‘’Until last year, the regulator was approaching the growing interest in options trading as an issue related to investor protection, but it has now become a macro issue, said Madhabi Puri Buch, Chairperson, SEBI. Based on the measures suggested by an expert panel, SEBI proposed the following seven key measures for stock exchanges and clearing corporations to adopt:

Also Read: Zerodha’s Nithin Kamath says SEBI suggestions on F&O ‘won’t really change options volumes’ despite STT hike

1.Rationalization of strike price for option

SEBI has proposed rationalising the strike price methodology. ‘’The strike interval will be uniform near the prevailing index price (four per cent around the prevailing price) and will increase as the strikes move away from the prevailing price (around four per cent to eight per cent),'' said SEBI. The market regulator added that not more than 50 strikes would be introduced for an index derivatives contract at the time of contract launch.

2.Upfront collection of options premium

Options prices, depending on the moneyness, move in a non-linear way and thus carry very high implicit leverage. These are timed contracts with the possibility of very fast-paced price appreciation and depreciation. To avoid any undue intraday leverage to the end client and to discourage any market-wide practice of allowing positions beyond the collateral at the end client level, SEBI has proposed to mandate the collection of options premium upfront from the buyer of the option.

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3.Removal of calendar spread benefit on expiry day

SEBI said that given the skew in volumes witnessed on the expiry day vis-à-vis other non-expiry days and the inherent basis and liquidity risk present, the margin benefit for calendar spread position would not be provided for positions involving any contracts expiring on the same day.

4.Intraday monitoring of position limits

Given the evolving market structure, the position limits for index derivative contracts shall also be monitored by the clearing corporations/ stock exchanges intra-day, with an appropriate short-term fix and a glide path for full implementation, given the need for corresponding technology changes.

5.Minimum contract size

SEBI proposed that the minimum contract size for index derivative contracts must be revised in two phases:
Phase 1: Minimum value of derivatives contract at the time of introduction to be between ₹15 lakhs to ₹20 lakhs
Phase 2: After six months, the minimum value of the derivatives contract to be between ₹20 lakhs to ₹30 lakhs.

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6.Rationalization of weekly index products

Given there is an expiry of weekly contracts on all five trading days of the week combined with previous findings on increased volatility on expiry day and within that increased volatility during closing time, speculative activity created near contract expiry and poor profitability outcome for individual investors in F&O segment, rationalization is warranted in the product offering.

7.Increase in margin near contract expiry

To address the issue of high implicit leverage in options contracts near expiry, which creates a high risk on a notional basis for entities dealing in options, SEBI proposed increasing the Extreme Loss Margin (ELM) by three per cent to five per cent.

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What SEBI's study revealed

SEBI revealed in its recent study that 92.5 lakh retail traders and proprietorship firms incurred a trading loss of ₹51,689 crore in FY24. Out of these 92.50 lakhs unique investors, 14.22 lakhs investors made net profit i.e. approximately 85 out of 100 made a net trading loss.

SEBI found that over and above the trading losses, the loss makers expended an additional 23 per cent of trading losses as transaction costs, while profit makers spent additional 15 per cent of their trading profits as transaction costs during FY22. After considering the transaction costs, the outcome for FY24 will likely be very comparable to the FY22 study, which found nine out of 10 losing money.

To put these numbers in perspective, the absolute value of the net trading oss borne by individuals during FY24 in index derivatives in index derivativesis over 32 per cent of the net inflows into the growth and equity oriented schemes of all mutual funds during FY24. It is also over 25 per cent of the average annual inflows into all funds across all schemes over the past five years.

Also Read: SEBI chief Madhabi Puri Buch says F&O volume surge a ‘macro issue’ now, not ‘micro issue of investor safety’
 

Budget 2024 hikes STT on F&O trading

Finance Minister Nirmala Sitharaman announced a significant hike in the the securities transaction tax (STT) from 0.01 per cent to 0.02 per cent while presenting Union Budget 2024 on July 23. This means that equity and index traders will face double the tax on their trades nvolved in futures and options (F&O) transactions, once the proposal comes into effect, i.e., from October 1, 2024.