New Delhi: The Securities and Exchange Board of India (SEBI) proposal to tighten the criteria for underlying stocks to be eligible for trading in the futures and options (F&O) market aims to strengthen the market and protect investors, according to SEBI and market analysts.
The SEBI released a consultation paper Saturday, detailing its proposals for the eligibility norms for stock trading and requesting stakeholders to comment by 19 June.
Not all stocks in the stock market are eligible for trading in the F&O market. They need to pass some eligibility norms, last reviewed in 2018.
Their revision is now necessary again, according to SEBI. This is because India’s stock and derivatives markets, comprising futures and options, have grown considerably since the last review. “The last review of the eligibility criteria for introduction of stocks in the derivatives segment was conducted in 2018,” the SEBI paper said.
Adding, “Since then, market parameters reflecting the size and liquidity of the cash market, viz., market capitalisation and turnover, have moved up considerably.”
According to SEBI data, India’s benchmark stock indices, the Nifty 50 and the Sensex, have grown 110 percent and 109 percent, respectively, between May 2018 and May 2024.
India’s market capitalisation, a measure of the value of all the stocks available for trading in the stock market, grew 178 percent over this period.
ThePrint reported last month how India now accounts for nearly 90 percent of the volume of all options contracts traded globally. This share was just 37 percent in 2019, highlighting the spectacular growth that India has seen in this segment of trading.
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Reducing risks to new investors
In its paper, SEBI said that without tightening its norms and ensuring only high-quality stocks make it to the F&O category, “there can be higher risks of market manipulation, increased volatility, and compromised investor protection”.
According to Anand James, Chief Market Strategist at Geojit Financial Services, several stocks in the F&O segment do not see much activity.
“Even when we make recommendations to our customers, we first weed out these stocks that are largely inactive,” he said.
The risk from these inactive stocks is more for new investors unaware of how options trading works.
“A new investor, not familiar with how options work and is familiar with a particular stock in the conventional stock market, will want to take a position on this stock in the futures or options market as well,” James said. “But, because of the low volumes in this stock in the F&O segment, there won’t be enough bids.”
As a result, he said, there is a higher possibility that a new customer could suffer losses with these less active stocks in the F&O market.
ThePrint’s report in May highlighted a SEBI study revealing how nine out of 10 Indian retail traders in the F&O segment lost money over the year and how the value of these losses had been growing.
“Given all this, there is a need for SEBI to ensure that only high-quality stocks in terms of size, liquidity, and market depth are available in the derivatives segment,” the SEBI paper said. “In line with this, the extant market parameters for eligibility in the derivatives segment need to be readjusted to keep pace with the evolving market conditions.”
Overall, James said, these changes are positive and welcome since they will strengthen the F&O market. “What it will do is leave only the highly active and stronger F&O stocks, which is a positive for the market, as well as for traders.”
New kids on the F&O block
According to SEBI, currently, 182 stocks get traded in the F&O segment compared with 209 when the last review of the rules took place.
An analysis by Nuvama Institutional Equities found that 24 of these stocks would not remain in the F&O category if the new criteria were implemented.
On the other hand, it added that roughly 76 stocks currently not in the segment would become eligible for the F&O category, although the final decision would be SEBI’s.
The additions could include newer stocks like Zomato, Jio Financial and One97 (the owner of PayTM) and stalwarts of the stock exchanges such as IRFC and Oil India and several public sector banks, according to Nuvama.
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Eligibility criteria significantly tightened
Several technical metrics are used to measure the activity and depth of a particular stock in the stock market. SEBI has proposed increasing the minimum limits on almost all the metrics for a stock to qualify for F&O trading.
First, it proposed that the stock’s Median Quarter Sigma Order Size (MQSOS) over the last six months, on a rolling basis, should not be less than Rs 75-100 lakh. The current limit is Rs 25 lakh.
The quarter sigma order size is the size of an order that can cause a change in the stock price equal to one-quarter of a standard deviation. The less active a stock, the more likely single trades can cause large fluctuations in its price. So, only those stocks that do not see too much price deviation will be allowed in the F&O segment if the proposal is accepted.
“Since average market turnover is now over 3.5 times the figure during the last review, MQSOS criteria would need to increase between 3-4 times,” SEBI said.
Similarly, the markets regulator has proposed that the stock’s market-wide position limit (MWPL) on a rolling basis should not be lower than Rs 1,250-1,750 crore, up from the previous limit of Rs 500 crore.
The MWPL is the maximum number of open (not yet settled) F&O contracts permitted for a particular underlying stock. It is an indication of the interest and activity in the stock.
Bringing ‘product success’ to stock derivatives
SEBI earlier introduced a Product Success Framework (PSF) for index derivatives — futures or options where the underlying commodity is an index. This framework mandates that derivatives on an index should have “sufficient turnover, open interest, and widespread participation”, according to SEBI.
If any index fails to satisfy any of these criteria, then no fresh contracts shall be issued on that index. SEBI proposes to add such a framework for single-stock derivatives as well.
“On similar lines, it is proposed to introduce additional exit criteria for single stock derivatives, based on the performance of derivative contracts,” SEBI added.
(Edited by Madhurita Goswami)
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