SEBI's New Circular (SEBI New Rule) on Equity Index Derivatives: What It Means for Investors

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SEBI's New Circular (SEBI New Rule) on Equity Index Derivatives: What It Means for Investors

The Securities and Exchange Board of India (SEBI) issued a new circular on October 1, 2024, introducing significant changes to the equity index derivatives framework. These measures aim to increase investor protection, promote market stability, and regulate speculative trading, particularly in index derivatives.

In this blog, we’ll break down the key points of SEBI’s new circular, its impact on investors, and what these changes mean for the future of the stock market.

 

Key Changes in SEBI’s New Rule

1. Upfront Collection of Option Premium from Buyers

What’s New: SEBI has mandated that brokers must collect the entire options premium upfront from buyers. This change will be implemented from February 1, 2025.
Why It’s Important: This measure ensures that investors can only take positions if they have enough funds, reducing intraday leverage. This will discourage excessive speculative trading and prevent clients from taking on risky positions they can’t afford.
Example: If you buy an option with a premium of ₹10,000, you will need to pay the full ₹10,000 upfront to your broker, eliminating any risk of default during price fluctuations.

2. Removal of Calendar Spread Treatment on Expiry Day

What’s New: SEBI has removed the calendar spread margin benefits on expiry day for contracts that expire on that day, effective from February 1, 2025.
Why It’s Important: On expiry day, contracts can become highly volatile. By removing the benefit of calendar spreads on such days, SEBI aims to minimize basis risk (the risk arising from differences in pricing between contracts of different expiries).
Example: If you have contracts expiring in the current week and the next week, they will not be considered offsetting positions on the expiry day. This change reduces risk but may require higher margins from traders on these days.

3. Intraday Monitoring of Position Limits

What’s New: From April 1, 2025, stock exchanges will conduct intraday monitoring of position limits in index derivatives contracts, with at least 4 random snapshots taken daily.
Why It’s Important: This aims to prevent traders from exceeding permissible position limits during the trading day, particularly during high-volume trading on expiry days. It will help control excessive speculative activity.

4. Increase in Contract Size for Index Derivatives

What’s New: SEBI has increased the contract size for index derivatives from the current range of ₹5-10 lakh to a new range of ₹15-20 lakh, effective from November 20, 2024.
Why It’s Important: With rising market values, this increase ensures that only traders with sufficient funds can participate in the derivatives market. This change helps maintain suitability and risk management for participants.
Example: If you used to trade an index derivative contract valued at ₹7 lakh, you will now need to trade a contract worth at least ₹15 lakh. This could increase the margin requirements for smaller investors.

5. Rationalization of Weekly Index Derivatives

What’s New: From November 20, 2024, exchanges can only offer weekly derivatives contracts on one benchmark index. This is a move to reduce speculative trading in multiple indices.
Why It’s Important: SEBI noted that trading in weekly index options, especially on expiry day, has become highly speculative. By limiting weekly contracts to a single index, SEBI aims to reduce volatility and speculative behavior.

6. Increase in Tail Risk Coverage on Expiry Day

What’s New: SEBI has mandated an additional 2% margin for short options on the expiry day, effective from November 20, 2024.
Why It’s Important: This measure is intended to cover the tail risk on expiry day, where markets are highly volatile. It reduces the risk of heavy losses for brokers and clearing corporations.
Example: If you hold a short option contract due to expire, the margin required will increase by an additional 2% on the day of expiry to cover potential extreme price movements.

FAQs About SEBI’s New Circular

Q1: What is the purpose of collecting option premiums upfront?

A1: The upfront collection of option premiums ensures that traders have sufficient funds to take positions, reducing the risk of defaults and discouraging speculative trading beyond their financial capability.

Q2: How will the removal of calendar spread benefits impact traders?

A2: Traders who rely on margin benefits from calendar spreads will need to post additional margins on expiry day, as contracts expiring on that day will no longer offset each other. This change is designed to reduce risks associated with volatile price movements on expiry day.

Q3: Why is SEBI increasing the contract size for index derivatives?

A3: The increase in contract size reflects the growth in market prices and aims to maintain market integrity by ensuring that only financially capable participants engage in derivatives trading. This helps prevent small investors from over-leveraging.

Q4: How does rationalizing weekly index derivatives reduce speculative activity?

A4: By limiting weekly contracts to a single benchmark index, SEBI hopes to reduce the high levels of speculative trading seen on expiry days, which often leads to increased market volatility.

Q5: What is the impact of increasing tail risk coverage on expiry day?

A5: This additional margin requirement protects clearing corporations from extreme market moves on expiry day, particularly when traders hold short option positions. It provides a safety net against tail risks that are harder to predict.

Q6: What are new rules of SEBI for option trading?

A6: SEBI has introduced the rule for upfront collection of option premiums. Starting from February 1, 2025, brokers will be required to collect the full premium upfront from buyers at the time of purchasing options. This rule is designed to reduce the risk of excessive leverage by ensuring that clients have adequate funds before taking on a position in the options market.

 

Q7: What is the contract size in F&O?

A7: Under the new SEBI guidelines, the minimum contract size for index derivatives (both futures and options) has been increased. Effective from November 20, 2024, the contract size must be between ₹15 lakhs to ₹20 lakhs at the time of introduction to better align with market growth and reduce risks associated with smaller contract sizes.

 

Q8: What are the new SEBI rules for margin?

A8: SEBI has made several changes to margin rules:
Upfront Collection of Premium: Option buyers will need to pay the full premium upfront from February 1, 2025.
No Calendar Spread Margin Benefit on Expiry Day: From February 1, 2025, calendar spread margins will not apply on the expiry day for contracts expiring on that day.
Additional 2% Margin on Expiry Day: Short options will require an additional 2% margin to cover tail risk starting November 20, 2024.

 

Q9: What is the SEBI new rule for F&O implementation date? 

A9: The new SEBI rules for Futures & Options (F&O) trading will be implemented on different dates:

November 20, 2024: Contract size increase, weekly index rationalization, and tail risk margin increase.

February 1, 2025: Upfront option premium collection and removal of calendar spread margin benefits.
April 1, 2025: Intraday position monitoring.

 

These rules aim to enhance investor protection, minimize speculative trading, and promote market stability.

 

These changes are expected to have both immediate and long-term impacts on the stock market:

Reduced Speculation: By introducing tighter controls on margin requirements and position limits, SEBI aims to curb speculative trading in index derivatives. This will likely result in lower trading volumes on expiry days, particularly from retail investors.

Increased Stability: With stricter intraday monitoring and larger contract sizes, SEBI is pushing for greater market stability. Larger players with more capital will dominate the market, and the risk of volatile market movements will reduce.

Limited Participation from Small Traders: The increase in contract size and margin requirements may reduce participation from smaller investors, who will find it harder to meet the new financial requirements. However, this could also lead to more sustainable and less volatile market behavior.

More Capital for Brokers and Exchanges: With upfront premium collection and higher tail risk margins, brokers and exchanges will have more capital to manage risks, particularly during volatile periods like expiry days. Conclusion

SEBI’s new circular introduces significant reforms aimed at protecting investors and ensuring market stability. While these changes may limit speculative trading, they also enhance risk management and investor protection in the long term. Traders and investors need to stay informed about these upcoming changes, adjust their strategies, and prepare for the evolving landscape of the Indian derivatives market.

These measures are expected to create a more mature market, focusing on sustainability rather than short-term speculative gains.