SEBI plans to change the current methodology for computing open interest in equity derivatives from notional terms to a “future equivalent”, or delta-based one, and revise position limits for index derivatives.
The proposals aim to reduce instances where stocks are pushed into ban period without any extensive build-up of risk as well as mitigate the possibility and risk of circumvention of intended position limits for index derivatives (including via short positions). These changes will not materially affect small investors beyond reducing the frequency of stocks entering ban period, thereby simplifying their trading experience, the paper said.
Open interest in derivatives refers to the total outstanding positions held by all participants and is currently calculated by adding open interest of futures and options (in notional terms) for each investor.
The chances of stocks being pushed unnecessarily into ban periods is expected to reduce by 90 per cent, significantly enhancing trading convenience for a normal F&O trader, said a regulatory official. Also, the chances of entities running very large positions, especially in index options while notionally showing low open interest, would be dramatically reduced.
“The new measurement of risk along with suggested minimum conditions for construction of F&O indices should reduce the actual and perceived risk of any manipulation across cash and derivatives markets, and of excessive volatility,” the person said.
MWPL proposal
The regulator has proposed that the market-wide position limit (MWPL) for single stocks be set as the lower of 15 per cent of free-float market capitalisation or 60 times the average daily delivery value (ADDV) in the cash market across exchanges. This metric will be recalculated every three months based on the rolling ADDV for the preceding three-month period.
“Tying the MWPL to cash market delivery volumes will reduce potential manipulation and better align derivatives risk with the underlying cash market liquidity,” the regulator said. “To safeguard market integrity and limit settlement risk from intraday spikes, clearing corporations would perform intraday monitoring of MWPL at least four random times during the trading session.”
Other measures
Just like in the cash market, derivatives will now have pre-open and post-closing sessions for better price discovery. Initially, this will apply to current-month contracts, and in the last five days before expiry, to next-month contracts as well. This should help reduce volatility at market open/close. “Ideally, this should be everyday and not just five days before expiry. It’ll help reduce gaps and activate overnight passive orders in the pre-open session too,” said Tejas Khoday, CEO, FYERS.
To prevent excessive concentration risk, SEBI is proposing that any non-benchmark index must have at least 14 stocks, no single stock above 20 per cent weight, and the top three stocks together can’t exceed 45 per cent weight. “This ensures broader diversification and reduces index volatility risk in the future. It could also influence index constructions in the years to come,” said Khoday.
Single-stock derivative position limits limits will now factor in actual market-wide open interest. Instead of just MWPL-based limits, positions will also be tied to total open interest across exchanges. This prevents a single player from dominating illiquid stocks and distorting market pricing.