According to a circular from Sebi, several of the new derivative trading regulations, such as the rationalization of contracts to weekly expiries, will take effect on November 20.
Reducing expiries to once a week is one of many steps the market regulator Sebi has made to fortify the index derivative framework, safeguard investors, and enhance market stability. Each exchange will be allowed to provide derivatives contracts for just one of its benchmark index with weekly expiry.
The regulator has put out these safeguards after taking into consideration the extremely speculative character of trading on index derivatives, particularly on expiry day of the contracts.
When derivatives are first introduced to the market, the Securities and Exchange Board of India (Sebi) has raised the minimum trading value from the current Rs 5–10 lakhs to Rs 15 lakh. After that, it will be increased to a maximum of Rs 20 lakh. According to the market regulator’s press release, “the lot size shall be fixed in such a manner that the contract value of the derivative on the day of review is within Rs. 15 lakhs to Rs. 20 lakhs.”
Beginning on November 20, the new standards for derivative trading will be implemented gradually. On that day, index derivative contracts will be introduced with weekly expiries, larger contract sizes, and increased tail risk coverage by the imposition of additional extreme loss margin (ELM).
Beginning on February 1, 2025, buyers of options will have their option premium collected upfront, and the calendar spread treatment will be removed on the day of expiration. There will be intraday monitoring of position limits starting on April 1, 2025.
Daily expirations are no longer available.
When option premiums are low, expiry day trading in index options is mostly speculative, according to the regulator. Every day of the week, stock exchanges offer contracts with weekly expirations. According to the regulator’s consultation document, there is heightened volatility in the index’s value throughout the day and on expiry, along with hyperactive trading in index options on expiry day, with average position holding periods measured in minutes.
According to Sebi, “All this has implications for investor protection and market stability, with no discernable benefit towards sustained capital formation.”
As a result, each exchange is only allowed to hold derivative contracts for a single index per week, per regulatory regulation.
Higher contract size
In 2015, the present contract sizes were established. Given how the market has changed and grown–with market value and prices having gone up 3x since–the regulator concluded that it was time for another review in the interest of maintaining market stability and ensuring that players are only assuming reasonable risk.
According to Sebi’s statement, “Given the inherent leverage and higher risk in derivatives, this recalibration in minimum contract size, in tune with the growth of the market, would ensure that an inbuilt suitability and appropriateness criteria for participants is maintained as intended.”
Higher margin requirement
Investors pay for extreme loss margin, or ELM, to cover severe market events (tail risk). The regulator has decided to request an additional 2 percent ELM from the investors due to the observation of excessive speculative behavior on expiry days.
This would apply to all open short options at the beginning of the day as well as any contracts for short options that are started during the day and have an expiration date that same day. For example, if an index contract has a weekly expiry on the seventh of the month and there are other weekly/monthly expiries on the index on the fourteenth, twenty-first, and twenty-eighth, then there would be an extra ELM of 2% on the seventh for all the options contracts that expire on the seventh.
Upfront collection of premium
In October 2023, the regulator ordered brokers to take margin upfront. The regulator has now requested that the brokers receive net option premiums (price) too upfront, in light of the extreme volatility of option prices during the day. The statement from Sebi stated, “In order to avoid any undue intraday leverage to the end-client, and to discourage any practice of allowing any positions beyond the collateral at the end-client level, it has been decided to mandate collection of options premium upfront from option buyers by the Trading Member (TM)/ Clearing Member (CM).”
Calendar-spread no more
Contracts that expire on that day will not be eligible for the advantage of calendar spread, which is the offsetting of positions across different expiries. According to Sebi, this decision was made after realizing that the value of a contract that expires on a given day can fluctuate significantly from the value of comparable contracts that expire later.
The statement further stated, “Given the relatively very large volumes witnessed on the expiry day vis-à-vis future expiry days, and the enhanced basis risk that it represents, it has been decided that the benefit of offsetting positions across different expiries (‘calendar spread’) shall not be available on the day of expiry for contracts expiring on that day.”
Intraday position limits
Index contract position limitations are now recorded at the end of each day. The regulator has mandated that clearing corporations and stock exchanges now record these position limitations at least four times a day (the frequency can be modified to suit the convenience of the exchanges or CC).
The statement further stated that “amidst the large volumes of trading on expiry day, there is a possibility of undetected intraday positions beyond permissible limits during the course of the day.”
It stated, “To address the aforesaid risk of position creation beyond permissible limits, it has been decided that existing position limits for equity index derivatives shall henceforth also be monitored intra-day by exchanges.”