New Delhi: As part of its ongoing bid to dampen the “hyperactivity” in India’s derivatives market, market regulator Securities and Exchange Board of India (SEBI) has suggested a number of changes, including increasing the minimum contract size for futures and options, limiting the number of weekly index options, and mandating that the premium on options be collected on an upfront basis.
In a consultation paper released Tuesday, SEBI pointed out that the losses incurred by those trading in index derivatives was substantial — cumulatively amounting to more than Rs 51,000 crore in 2023-24 — and that this figure does not include the transaction costs associated with these trades.
It added that the figures for 2023-24 would “likely be comparable” to those found in its 2023 study that said that nine out of every 10 traders in derivatives made a loss.
Previously, both SEBI and the Reserve Bank of India (RBI) have voiced concerns over the heightened activity in the derivatives market. In Budget 2024 announced last week, the government raised the securities transaction tax (STT) on such trades in a bid to dampen the activity.
While some market commentators welcomed SEBI’s proposals, there are others — including government officials and market participants — who have said that neither the tax increase nor the proposed changes by SEBI will be substantially successful in dampening the activity in the options market in India.
Retailer traders losing, algo-traders profiting
“For FY 2023-24, 92.50 lakhs unique individuals and proprietorship firms traded in index derivatives segment of NSE (National Stock Exchange) and cumulatively incurred a trading loss of Rs 51,689 crore,” the consultation paper said. “This figure doesn’t include transaction costs.”
“Further, of these 92.50 lakhs unique investors, 14.22 lakhs investors made net profit i.e. approximately 85 out of 100 made a net trading loss,” it added.
Notably, SEBI also pointed out that, while retail traders were largely making losses in the derivatives segment, larger non-individual players that use high-frequency algorithmic-based proprietary trading software and foreign portfolio investors (FPIs), are the ones that are in general making offsetting profits.
“In view of the aforesaid findings around increased speculative/trading hyperactivity in index options segment combined with poor profitability outcome for individual investors, SEBI, with an objective of actively enhancing investor protection and ensuring market stability, created an Expert Working Group (EWG) to examine the matter further,” SEBI said.
This expert committee submitted its recommendations to SEBI’s Secondary Market Advisory Committee, which made recommendations of its own based on the submission.
“Pursuant to the recommendations of the SMAC, SEBI, with an objective to strengthen the derivatives framework for enhancing investor protection and ensuring market stability, is proposing certain near-term measures in the index derivatives segment,” the paper said.
Making derivatives more expensive, less frequent
One of the more significant proposals in the paper, meant to put options trading out of the reach of smaller retail players, is to increase the minimum size of options contracts from the current band of Rs 5-10 lakh to Rs 15-20 lakh and then Rs 20-30 lakh over a phased manner.
According to Deepak Shenoy, founder and CEO of Capitalmind, a SEBI-registered portfolio management company, such a move would hurt traders with smaller capital levels.
Another suggestion to limit the availability of opportunities to speculate in the options market is to reduce the number of weekly options on offer.
“Weekly expiry index derivatives contracts are offered by stock exchanges in addition to monthly contracts,” the paper noted. “There is expiry of such weekly contracts on all five trading days of the week across different indices/exchanges… resulting in speculative money moving from one expiry of index to another every single day.”
It further noted that the availability of weekly expiries on every single trading day, coupled with its findings of increased volatility and speculative activity created near contract expiry and poor profitability outcome for individual investors in F&O segment, “rationalisation is warranted in the product offering”.
This proposed rationalisation is to limit weekly options contracts to a single benchmark index of an exchange.
The third proposal is to mandate that the premiums that are charged on options contracts be collected on an upfront basis rather than with a delayed effect, since that was encouraging buyers to buy contracts in excess of the collateral they had on hand.
“In order to avoid any undue intraday leverage to end clients and to discourage any market wide practice of allowing position beyond the collateral at the end client level, it is desirable to mandate collection of options premium upfront… from the options buyer,” the paper proposed.
Govt & regulator moves to have limited impact
Nithin Kamath, founder and CEO of discount brokerage Zerodha, took to X to point out that the recommendations in the consultation paper would not impact the volumes in the options market, and would even encourage traders in the futures market to move to the options market.
“The suggested changes, even with the STT increase, won’t really change options volumes,” Kamath wrote. “But on the flipside, they will reduce futures volumes. If the intent is to reduce speculation, then the solution is maybe to make it harder for non-serious people to trade by having a product suitability framework.”
On the other hand, V.K. Vijayakumar, chief investment strategist at Geojit Financial Services welcomed SEBI’s proposals, saying this would curb the “irrational exuberance” of retail investors in this segment.
“SEBI’s crackdown on F&O trade is eminently desirable and can go a long way towards making the ongoing rally healthy and less speculative,” Vijayakumar said. “The irrational exuberance of the retail investors, particularly the newbies who entered the market after the Covid crash, will do more harm than good to the overall market in the long run. Therefore, these regulatory measures are to be welcomed.”
That said, Finance Secretary T.V. Somanathan last week indicated to ThePrint that the increase in the STT announced in the Budget wouldn’t themselves dampen the activity in the derivatives market.
While acknowledging that the move to increase the STT was an attempt to dampen the over-enthusiasm in the derivatives market, Somanathan said he “was not sure that this alone will reduce volumes considerably”.
(Edited by Zinnia Ray)
Also read: 71% of intraday traders incur losses, finds SEBI report. Impact higher among young, small traders