Sebi''s Proposal to Curb Index Derivatives Volatility: Impact & Expert Views

New Delhi, Jul 31 (PTI) Markets regulator Sebi's proposal on tightening rules for index derivatives if implemented may result in erosion of volumes from Futures & Options (F&O), experts said on Wednesday.

At the same time, it will enhance investor protection and promote market stability in derivatives markets, they added.

In its consultation paper on Tuesday, the regulator has proposed seven measures, including increasing minimum contract size and upfront collection of option premiums, intra-day monitoring of position limits, rationalisation of strike prices, removal of calendar spread benefit on expiry day and increase in near contract expiry margin.

One of the proposals is to rationalise weekly expiry and restrict it to one per week on the benchmark index per exchange. This change will likely impact volumes, as the recent volumes in the equity derivatives segment have been driven by weekly expiries, HDFC Securities MD & CEO Dhiraj Relli said.

"Reducing volumes in F&O will bring down the realised daily volatility and also intra-day volatility in Nifty induced because there is an expiry practically on all days. This happens because large weights are common across most indices. For example, HDFC is a part of Fin Nifty, Bank Nifty, Nifty and Sensex," Anand Rathi Wealth Ltd Deputy CEO Feroze Azeez said.

Additionally, these measures are likely to lead to a reduction in monthly option prices, particularly for OTM options, resulting in lower implied volatility and a more balanced skewness in option pricing. This shift will make the market more accessible and less risky for investors, he added.

Furthermore, concentrating volumes at fewer strike levels will not only maintain but potentially enhance liquidity at these strikes, thereby reducing the impact cost for large traders.

Overall, these measures are expected to foster a healthier trading environment, promoting sustainable growth in the derivatives market.

PHDCCI Chair-Capital Market & Commodity Market Committee B K Sabharwal believes "if all the seven proposals are implemented as suggested in parallel, this could result in erosion of volumes from derivatives in a significant manner".

In 2014, Korea implemented similar measures in the backdrop of similar concerns. However, the market there never recovered despite many attempts by the regulators to revive business activity and even 10 years later the volumes are lower than in 2014, Sabharwal said.

"It would be therefore important for Sebi to implement changes only in a phased manner so that the overall vibrancy of the market is not impacted by too many hard measures at one time," he added.

The consultation paper comes days after the government in the Union Budget raised the securities transaction tax (STT) on both futures and options trade from October 1 to allay concerns about hyperactive interest in the derivative segment.

Before that, the Economic Survey flagged concerns over rising retail investors' interest in derivative trading. The survey stated that speculative trade has no place in a developing country.

It also pointed out that the sharp increase in retail investor participation in F&O trading is likely driven by humans' gambling instincts.

"With the realignment of exchange transaction charges, higher STT introduced in the Budget, and the proposed regulatory framework, it is expected that there could be a rationalisation in equity derivatives volumes," Amit Goel, Co-Founder & Chief Global Strategist, Pace 360, said.

Sebi, in its consultation paper, said derivatives market assists in better price discovery, help improve market liquidity and allow investors to manage their risks better.

"However, bursts of speculative hyperactivity in derivative markets, particularly by individual players, can detract from sustained capital formation by endangering both investor protection and market stability," it added.

Sebi Chief Madhabi Puri Buch on Tuesday mentioned that households are losing up to Rs 60,000 crore a year in the problematic futures and options segment.

A Sebi study had earlier pointed to 90 per cent of the trades resulting in losses. The capital markets regulator also came up with a consultation paper on Tuesday proposing ways to limit the activity.