SEBI’s New Derivatives Rules: Explained

On September 23, 2024, SEBI released a study that stated 9 out of 10 derivatives traders in the Futures & Options (F&O) segment lost money in FY24. In light of this, SEBI issued a circular on October 1, 2024, introducing several changes regarding derivatives.

These changes aim to enhance investor protection and maintain market stability. Let’s dive into these significant changes in detail.

Changes in the Derivatives Market

The derivatives market improves liquidity and provides investors the opportunity to manage their risk effectively. However, in recent years, the increasing participation of retail investors, the introduction of short-tenure index options contracts, and the surge in speculative activity on expiry day have significantly contributed to traders’ losses.

As a result, SEBI formed an Expert Working Group (EWG) that recommended measures for investor protection and market volatility management. Based on these recommendations, SEBI issued a consultation paper in July 2024, and after deliberation, introduced the following six changes in the derivatives market effective from October 1, 2024.

Upfront Collection of Option Premium from Options Buyers

Options are highly volatile and experience significant price fluctuations in a short time, offering the highest leverage. To mitigate unnecessary intraday leverage, SEBI has made it mandatory for trading and clearing members to collect upfront premiums from options buyers. This aims to prevent traders from taking risks beyond their deposited capital. This rule will be implemented from February 1, 2025.

Removal of Calendar Spread Benefits on Expiry Day

A calendar spread involves contracts with different expiry dates on the same underlying asset. SEBI observed that as these contracts approach expiration, the risks increase, causing rapid price swings. To address this, SEBI has decided to remove the margin benefits of calendar spreads near expiry, offering more protection to traders. This change will impact traders who use calendar spreads to reduce margins, and it will take effect on February 1, 2025.

Monitoring of Intraday Position Limits

To prevent violations of position limits during intraday trading, stock exchanges like NSE and BSE must take at least four position snapshots during the trading day. This will improve monitoring of traders who breach position limits, and this provision will be effective from April 1, 2025.

Change in Contract Size for Index Derivatives

Currently, the contract size for index derivatives ranges between Rs 5 lakh and Rs 10 lakh. Under the new provision, this size will be increased to Rs 15 lakh and Rs 20 lakh, ensuring safer investment options for investors. This change will come into effect on November 20, 2024.

Rationalisation of Weekly Index Derivative Products

Presently, one or more indices expire on each of the five trading days, leading to excessive index options trading and increased market volatility. To control this, SEBI has mandated that each exchange can now offer weekly derivative contracts on only one benchmark index. This change will take effect on November 20, 2024.

Increase in Tail Risk Coverage on Expiry Day

The increased speculative activity on expiry days heightens the risk in the stock market. To cover this risk, SEBI has decided to impose an additional 2% extreme loss margin (ELM) on all short options positions on expiry day. This rule will be effective from November 20, 2024.

Wrapping Up

These changes introduced by SEBI will strengthen investor protection and help maintain stability in the derivatives market. However, option traders may need to provide nearly two to three times more margin once these rules take effect. These reforms aim to safeguard investors’ interests and reduce unnecessary risk, which may limit participation from traders with smaller capital in the derivatives market.

That’s it for today. We hope you’ve found this article informative. Remember to spread the word among your friends. Until we meet again, stay curious!

This article is for informational purposes only. This is not investment advice. Disclaimer: Teji Mandi Disclaimer