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SEBI’s consultation paper on the F&O ecosystem

SEBI has released a consultation paper (https://tinyurl.com/mvannn7p) aimed at strengthening the index derivatives framework for increased investor protection and market stability. Most of the measures were part of a media report (https://tinyurl.com/yt5ztx4b) released three weeks ago. If the measures are replicated in the final regulations, volumes are likely to be hit both for retail participation (upfront premium collection and increase in lot size) and for HNIs/High Frequency Traders (removal of calendar spread benefit and additional margin for expiry). Exchanges and brokers stock prices have seen a correction since the media report. For brokers, price hikes can offset the impact. We have a BUY recommendation on ANGELONE and a Neutral rating on BSE.

Summary of the measures

Strike price rationalization (on expected lines)

NIFTY contracts have 35 In-the-Money and 35 Out-of-Money strikes at the time of introduction with an interval of 50 points. BANKNIFTY contracts have 45 In the Money and 45 Out of Money strikes at the time of introduction. Due to this, the options strikes cover roughly 7% to 8% of the index movement around the prevailing index price at the time of introduction.

New measures

* Strike interval to be uniform near prevailing index price (4% around prevailing price) and the interval to increase as the strikes move away from prevailing price (around 4% to 8%). * Not more than 50 strikes would be introduced for an index derivatives contract at the time of contract launch.

* New strikes to be introduced to comply with aforesaid requirement (1) on a daily basis.

Upfront collection of options premium: Most brokers have a tight risk management system in place

* There is a stipulation for upfront collection of margin for futures position (both long and short) as well as options position (only short options require margin, whereas long options require payment of the options premium by buyers). There is no explicit stipulation of upfront collection of options premium from options buyer by members.

* To avoid any undue intraday leverage to the end client 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 by TM/ CM from the options buyer. At present, CCs block collateral at the CM level for options buy trades.

* New measure: The members to collect option premiums on an upfront basis from the clients.

Intraday monitoring of position limits: Most brokers have a tight risk management system in place

* New measure: Given the evolving market structure, the position limits for index derivative contracts shall also be monitored by the clearing corporations/ stock exchanges on intra-day basis, with an appropriate short-term fix and a glide path for full implementation, given the need for corresponding technology changes.

Removal of calendar spread benefit on the expiry day:

* New measure: Given the skew in volumes witnessed on the expiry day vis-à-vis other non-expiry days and the inherent basis and liquidity risk present therewith, the margin benefit for calendar spread positions would not be provided for positions involving any of the contracts expiring on the same day.

Minimum contract size: on expected lines

* The minimum contract size requirement for derivative contracts (i.e., INR0.5m to INR1m) was last set in 2015.

* New measures:

* Phase 1: Minimum value of derivatives contract at the time of introduction to be between INR1.5m to INR2m.

* Phase 2: After six months, the minimum value of derivatives contract will be between the interval of INR2m and INR3m.

Rationalization of weekly index products: (Worse than expected)

* New measure: In view of the data provided in the preceding paragraphs, to enhance investor protection and promote market stability in derivative markets, weekly options contracts are to be provided on single benchmark index of an exchange.

Increase in margin near contract expiry: Worse than expected

New measure:

* At the start of the day before expiry, Extreme Loss Margin (ELM) to be increased by 3%.

* At the start of expiry day, ELM to be further increased by 5%.

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SEBI Registration number is INH000000412