The surge in trading in equity futures and options segment has been repeatedly highlighted by the markets regulator, Securities and Exchange Board of India (SEBI) in the past few years. Not only has the derivative trading volume been doubling almost every year since 2020-21, it is also many times higher than the trading in the cash segment. It is therefore welcome that the regulator is considering measures to check excessive speculation and improve risk monitoring in the equity futures and options segment, as revealed in a recent consultation paper. The proposal to change the method for calculating position limits in index options will be particularly helpful in checking this runaway speculation.
Index options in Nifty50, Bank Nifty, Nifty IT and Sensex attract a bulk of the trading interest in equity derivatives. While the regulator has set a limit of ₹500 crore for positions that individuals, HNIs, proprietary traders, FPIs and others can hold in each index derivative contract, it is calculated by netting the long and short positions. This allows traders to hold large positions on a gross basis. SEBI is proposing that revised intra-day limits in index options will be ₹1,000 crore on a net basis and ₹2,500 crore on a gross basis. The limits for end of the day positions are proposed at ₹500 crore on net basis and ₹1,500 crore on gross basis. These limits will be for positions not backed by underlying cash positions or other collaterals. It is reported that this move will impact large proprietary traders and foreign portfolio investors who have gross intraday positions exceeding ₹3,000 to ₹3,500 crore. But that need not deter SEBI. Some moderation in trading turnover may not be bad, given the surge since the pandemic.
The other significant change being proposed by SEBI is to change the way open interest (outstanding position held by all participants) in equity futures and options is calculated. It is currently arrived at by adding the notional value of the derivative contracts held by traders. SEBI is proposing to calculate this by adding the notional open interest in futures contracts with the future equivalent value in option contracts. This is a more accurate representation of the open interest in options, as it captures the risk taken while holding options more accurately. Future equivalent value of deep out-of-the-money options will be much lower than the notional value, thus bringing down the total open interest in each security. This will prevent derivatives being pushed into a ban period.
SEBI’s proposal regarding market-wide position limit (total value of all contracts traded in a security) will ensure that there is a link between trading in cash segment and derivative segment in each security. The regulator is proposing that the MWPL of a security should be lower of 15 per cent of free float market capitalisation or 60 times the stocks’ average daily delivery value in the cash segment. This along with the use of future equivalent value for open interest in options will bring greater stability to derivatives trading.