Securities and Exchange Board of India’s proposed F&O rules : Spillover of trading activity from these contracts into remaining products, analysts believe, can limit the impact to 20-25%
Securities and Exchange Board of India’s proposed F&O rules impact:Exchanges and brokers focused on retail traders are likely to face the most major effects from these changes, Jayant Kharote and Prakhar Sharma, equity analysts at Jefferies said.
This comes after Securities and Exchange Board of India proposed seven key amendments to the derivatives trading framework, aiming to bolster investor protection and market stability, on Tuesday.
Decoded Securities and Exchange Board of India’s proposals to curb speculation in F&O: The market regulator on July 30 proposed these seven measures in its consultation paper on index derivatives framework.
The Securities and Exchange Board of India (Sebi) on Tuesday released a consultation paper on measures to strengthen index derivatives (futures & options) framework for increased investor protection and market stability.
The objective of the proposed measures is to enhance investor protection and promoter market stability in derivatives markets, while ensuring sustained capital formation.
Here’s all that you need to know about what measures the Securities and Exchange Board of India has proposed, how will these impact derivatives |(F&O) traders and what does expert opine on the same.
Here are the SEVEN key Securities and Exchange Board of India proposals in the F&O consultation paper?
1. Rationalization of strike price for options
Existing Practice:Nifty and Bank Nifty options strikes cover roughly 7-8 per cent of index movement on the given day, with additional strikes introduced if the situation warrants so. Nifty has a total of up to 70 options strikes, while Bank Nifty around 90.
Proposed:Not more than 50 strikes to be introduced at the time of contract launch. Strike interval to be uniform near prevailing price (around 4 per cent) and may go up to 8 per cent if need be.
2. Upfront collection of options premium
Existing Practice:There is a stipulation to collect margin for futures positions both on the long and sell side; and short positions in options. However, there is no stipulation of upfront collection of options premium from options buyer.
Proposed:To collect Option premiums on an upfront basis.
3. Removal of calendar spread benefit on expiry day
Existing Practice:Calendar spread margin applies on expiry day for two F&O positions with different expiries as against two normal F&O positions. This helps in significantly reducing margin requirement.
Proposal:No calendar spread margin for contracts expiring on the same day.
4. Intraday monitoring of position limits
Existing Practice:Limits monitored at the end of the day by MIIs (Clearing Corporations/ Stock Exchanges)
Proposed:Position limits for index derivatives to be monitored on intra-day basis, with an appropriate short-term fix, and a glide path for full implementation.
5. Minimum contract size
Existing Practice:Minimum contract size requirement of Rs 5 – Rs 10 lakh was set in 2015.
Proposed:In Phase 1, the minimum value at the time of contract introduction to be between Rs 15 – Rs 20 lakh. Phase 2, after 6 months, implementation of minimum contract size of Rs 20 – Rs 30 lakh proposed.
6. Rationalization of weekly index products
Existing Practice:Weekly expiry of index derivatives has resulted into one expiry every single day of the week across indices/ exchanges.
Proposed:Weekly expiry for 1 benchmark index per exchange.
7. Increase in margin near contract expiry
Existing Practice:No additional margin required in the last two trading days of the expiry.
Proposed:Additional 3 per cent Extreme Loss Margin (ELM) to be collected at the start of penultimate day of the contract expiry. On the last day, ELM to be increased to 5 per cent.
Why did Securities and Exchange Board of India propose these measures?
While releasing the consultation paper, Securities and Exchange Board of India chief Mahabai Puri Buch said an annual loss of Rs 50,000 – Rs 60,000 crore of household savings through derivatives trading is a macro concern. The same money could get deployed into IPOs, mutual funds or other productive use for the Indian economy.
Securities and Exchange Board of India believes there is excessive speculative trading activity taking place in F&O. NSE data shows that retail investors alone account for around 50 per cent of the trading volumes in index derivatives; leaving behind proprietorship traders, foreign investors and domestic institutional investors.
As per Securities and Exchange Board of India, the cumulative trading loss incurred by 9.25 million unique individuals and proprietorship traders in the index derivatives of NSE along stood at Rs 51,689 crore in FY24.
What happens next?
With publication of this Consultation paper, Securities and Exchange Board of India has invited public comments and suggestions from other interested stakeholders along with support rationale through its web based portal or alternatively via email latest by August 20, 2024.
What experts have to say?
Dhiraj Relli, MD & CEO of HDFC Securities believes that the measures announced by Securities and Exchange Board of India are to control the exuberance in equity derivatives; and the proposal to rationalize weekly expiry shall impact trading volumes.
“One of the proposals is to rationalize weekly expiry and restrict it to one per week on the benchmark index per Exchange. This change will likely impact volumes, as the recent volumes in the equity derivatives segment have been driven by weekly expiries.” said Dhiraj Relli in a note.
These may not be the only interventions by the regulator. We may see more measures, including product suitability, customer-level certification, etc. With the realignment of Exchange transaction charges, higher STT introduced in the budget, and the proposed regulatory framework, it is expected that there could be rationalization in Equity Derivatives volumes, Dhiraj added.
Meanwhile, foreign investment firm Jefferiesbelieves the Securities and Exchange Board of India proposals could see divergent impact on market players; with exchanges and retail-focused brokers being most affected.
Securities and Exchange Board of India proposed F&O rules
Clearing members like Nuvama (Asset Services business) catering to institutional players, such as high frequency trading (HFTs) and foreign portfolio investors (FPIs), analysts believe, might experience minimal direct impact, although there could be secondary effects. For example, the removal of the Bankex weekly contract on the BSE could reduce EPS by 7-9 per cent over FY25-27.
“In our scenario analysis, gains from spillover of trading activity from discontinued products can offset EPS impact and in the event of moderate industry-wide impact of Securities and Exchange Board of India (Sebi) measures, can even drive earnings per share (EPS) upgrades,” Jefferies added.
Furthermore, Jefferies said discount brokers like Zerodha, Angel One, and Paytm Money, etc. will have a very high impact from tightening of F&O market and recent order on transaction charges.
For traditional brokers including MOFSL, IIFL Securities, ICICI Sec, etc, analysts said, will have ‘high’ impact from tightening of F&O market and ‘low’ impact from recent order on transaction charges.
That apart, Sebi’s proposed F&O measures will remove 12 (of 18) weekly option contracts & impact approximately 35 per cent of industry premiums, analysts said.
Spillover of trading activity from these contracts into remaining products, analysts believe, can limit the impact to 20-25 per cent.
They further said that phased hike in lot sizes (by 3-4x) and margin hike near expiry can impact retail traders. “Exchanges and retail-focused brokers will be most impacted. BSE can offset impact and even gain, if volumes spillover from discontinued products,” Jefferies said in a note.
Key changes and the impact explained:
Reduction in weekly option contracts
One of the most key changes, analysts said, is the reduction of weekly option contracts to one benchmark index per exchange, totaling six weekly contracts per month (down from 18).
However, monthly contracts, which occur in the fourth week of the month, will remain unchanged.
Meanwhile, weekly premiums currently account for approximately 65 per cent of the industry’s total premiums. The reduction, analysts believe, could eliminate about 35 per cent of these premiums. However, if trading activity shifts to the remaining two products, the overall impact on the market could be contained to 20-25 per cent.
Increased lot sizes to impact retail participation
SEBI’s proposal to increase lot sizes by 3-4 times over the next six months is likely to reduce retail participation due to higher ticket sizes, particularly on expiry days, Jefferies said in a note.
“While small retail (less than Rs 1 million monthly premiums) make up less than 3 per cent of system premiums, overall impact from their reduced participation can be magnified as they may be contributing to the profit pool disproportionately,” it added.
Higher margins and its effects
The proposed 8 percentage point increase in margins near expiry, analysts highlighted, will reduce leverage for option sellers, impacting profitability.
While institutional players with high leverage might absorb this change, High net worth individuals (HNIs) and retail individuals with lower leverage may struggle, potentially leading to reduced trading volumes if additional margin resources are unavailable, analysts added.
Strike price rationalisation, collecting premiums upfront, others
Other proposed changes, such as rationalising strike prices, collecting premiums upfront, removing calendar spreads, and intraday limit monitoring, analysts believe, are expected to enhance the quality of premiums in the long-term.
Source: Business Standard
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