sebi: Sebi’s seven-step plan to strengthen F&O framework: Is it feasible?

SebiThe seven-point proposal is motivated by the need to address emerging risks and challenges in the index derivatives market. By implementing these measures, the regulator aims to enhance the protection of retail investors by reducing complexity and risk, promote market stability by discouraging excessive speculation retail investors and foster meaningful market participation and support its growth by promoting investor confidence and engagement.

Let’s see how the proposed measures will impact the ecosystem:

1. Rationalization of option exercise prices

SEBI proposes to rationalize the strike price of weekly/monthly index option contracts to be uniform up to 4% around the prevailing index price and beyond to ensure fewer strike prices further away from the prevailing index price. In my view, this would not be practically feasible to implement as, if an investor were to take a position at a particular strike price on a particular day and time and then there is a movement in the prevailing index price, then the current price may go beyond 4% and then the question will be whether this strike price will continue or not; if it does not continue, it cannot be forcibly closed and if it continues, many strike prices will remain in the market beyond 4% as per the prevailing index price movement and these may become illiquid and prone to manipulation leading to further losses to investors which is intended to be safeguarded. Therefore, this does not seem feasible and should not be implemented.2. Advance payment of the option premium to option buyers

SEBI is proposing to ensure advance collection of option premium from option buyers and this is a welcome move in my opinion, furthermore I am surprised to know the fact that there was no explicit stipulation of advance collection of option premium from option buyers by stock brokers, we at Choice have been ensuring advance collection of option premium from option buyers since long and do not allow undue intra-day leverage to the end client, safeguarding the interest and integrity of the market.3. Elimination of the calendar spread benefit on the expiration day

SEBI proposes to remove the margin benefit for calendar spread positions involving any of the contracts expiring on the same day; in my view, this rationalisation will not have a major impact on retail investors, though few traders may be affected, but considering the objective of strengthening the derivatives framework to enhance investor protection and market stability, this may be attempted.

4. Intraday monitoring of position limits

SEBI’s proposal to monitor position limits for index derivative contracts by clearing corporations/stock exchanges is a welcome move; at Choice we make complete sure that no intraday positions are allowed beyond the permissible limits at any given time.

5. Minimum contract size

SEBI is proposing to increase the minimum contract size for index derivatives at the time of introduction to Rs.15-20 lakhs in phase one and Rs.20-30 lakhs in phase two after six months, in my opinion this move will not have much impact on the market as largely no one trades in 1 or 2 lots including retail trading in index derivatives, it will only result in reduction of contract traded but in terms of value it will largely remain the same. Secondly, major retail investors are option buyers who invest few thousand rupees in buying option premium, this increase in minimum contract size will not deter them as they are concerned about the investment quantum and not the lot size. Therefore SEBI can introduce the increase in phase one and see the outcome if it is favourable then phase 2 can be implemented, otherwise phase 2 should be avoided.

6. Rationalization of weekly index products

SEBI proposes to reduce the weekly options contract and provide it on a single benchmark of an exchange from the current 6 weekly index options contracts to 2 weekly index options contracts; in my opinion looking at SEBI’s objective of this consultation paper and the retail investors who lose a lot of money in index derivative options, this reduction is justifiable though it may have a negative impact on the community of traders who are good at this activity and earn a reasonable amount; furthermore, it will affect the overall volume on the exchanges and consequently will impact the profits of the stock exchanges and stock brokers as well, which looking at the overall objective may take a hit.

7. Margin increase near contract expiration

SEBI proposes to increase the Extreme Loss Margin (ELM) at the beginning of the day before expiry by 3% and at the beginning of the day of expiry by an additional 5% i.e. the day of expiry in total will increase by 8% as compared to the current scenario, in my opinion though the objective of the proposal is good but the implementation of this measure will create disturbances in the market in many ways. Firstly, the option buyer is not affected much as he has to invest a small amount but due to the increase in ELM there will be huge volatility before the day of increase and the probability of incurring losses will increase more than in the current scenario as they will go for forced adjustment of position and liquidity issues may be created due to which the probability of price manipulation will increase with people having huge fund backing. Secondly, the investors who have not adjusted the position before the increase will face shortage penalty and will incur more losses which will create unnecessary chaos in the market. Therefore, this measure proposed by SEBI is not at all effective and will lead to a situation worse than the current scenario.

Conclusion:

Sebi’s comprehensive 7-point plan to strengthen index derivatives framework is a very good initiative but as mentioned earlier two points are a welcome measure namely advance collection of option premium and intraday monitoring of position limits, three points namely removal of calendar spread benefit, minimum contract size and rationalisation of weekly index products are in good shape and can be implemented but the other two points namely rationalisation of option strike prices and increase in margin near contract expiry will disrupt the market abruptly and hence should be avoided.

Moreover, the main reason for this proposal is the losses incurred by retail investors due to a major shift in index derivatives options trading, but in my opinion, all the above measures will have very little impact on retail investors’ participation. Secondly, we should appreciate the universal theory of 80:20 ratios, according to which only 20% of people succeed and 80% fail in all areas of life, and this ratio changes a little in different areas. Therefore, we cannot stop the losses of 80% of people; on the other hand, we should also appreciate that the cost of new learning needs to be paid, and moreover, the data reflects the same: the younger category incurs more losses than the older one, so losses should be treated as an investment in learning.

In addition, SEBI may consider entry checkpoints for persons entering the derivatives market such as product suitability, so that only persons with knowledge of derivatives enter the derivatives market, one of which may be introduced through mandatory certification for all derivatives market participants.

(The author is the CEO of Choice Equity Broking and a member of the board of directors of its publicly traded parent company. International electionThe recommendations, suggestions, views and opinions of experts are their own and do not represent the views of the Economic Times.