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India's markets regulator has proposed tighter rules on trading in individual stock derivatives, arguing the rules were needed to avert risks of market manipulation after recent explosive growth particularly in options trading.

The move comes after two sources familiar with the matter told Reuters in April that India's top financial regulators would form a committee to assess stability risks emerging from a surge in derivatives markets.

Options trading has soared in India in the last five years, fueled mainly by retail investors so that the notional value of index options traded more than doubled in 2023-24 to $907.09 trillion from the year before, exchange operator NSE has said.

A discussion paper published on Sunday on the website of the Securities and Exchange Board of India (SEBI) said derivatives contracts on individual stocks should have sufficient liquidity and trading interest from market participants - currently a requirement only for contracts on indexes.

"Without sufficient depth in the underlying cash market and appropriate position limits around leveraged derivatives, there can be higher risks of market manipulation, increased volatility, and compromised investor protection," SEBI said.

Under the proposed rules, for a stock to be considered for futures and options (F&O) trading, it should have traded for 75% of trading days, SEBI said, without specifying over what period.

Also 15% of active derivatives traders should have traded the stock; average premium daily turnover should be 1.5 billion rupees ($18 million); average daily turnover must be between 5 and 15 billion rupees; and the maximum number of open F&O contracts permitted for the underlying stock must be 12.5-17.5 billion rupees. SEBI said, again without specifying any time periods.

The regulatory scrutiny comes after India’s top stock exchanges have been luring investors with new products and lower fees as they battle for a share of the burgeoning derivatives market, in turn fuelling a surge in trading activity.

Of the 108 billion options contracts traded worldwide in 2023, 78% were on Indian exchanges, according to data from the Futures Industry Association. Retail investors make up 35% of derivative trading in the country.

Financial services firm IIFL said in a research note that as many as 25 of the 182 stocks on which futures and options contracts are currently traded could be rendered ineligible for such trading if the regulator's proposals are implemented.

A discussion paper is the first step taken by Indian regulators to change policies or rules.

($1 = 83.5210 Indian rupees)