Consultation paper seeks to introduce measures to enhance investor protection and promote market stability in derivative markets while ensuring sustained capital formation.
Securities and Exchange Board of India (SEBI) has released a consultation paper aimed at enhancing investor protection and market stability in the derivatives market. The focus is on mitigating risks associated with speculative trading, particularly in index derivatives, where increased retail participation and short-tenure contracts have led to high volatility and market instability around expiry dates. The paper highlights the surge in trading activity and turnover in derivatives compared to the cash market, noting that individual investors, especially post-COVID, are driving significant turnover in index options. However, this has also led to a concentration of speculative trading around expiry days, resulting in heightened volatility and substantial losses for a majority of individual traders. SEBI’s paper suggests measures to address these issues, aiming to balance investor protection with market stability and ensure sustainable capital formation. The consultation invites public comments on these proposed measures to refine and strengthen the regulatory framework for index derivatives.
About Index derivatives
- Derivatives are financial contracts that draw their value from an underlying asset (commodity, security, currency, or index).
- Futures and Options (F&O) are common types of derivatives (refer to the box).
Need for Strengthening Index Derivatives Framework
- Excessive speculative trading: ₹50,000–₹60,000 crore of household savings lost through derivatives trading.
- Increased retail participation in equity derivatives: Index options rose from 2% of individual trades in FY 2018 to 41% in FY 2024.
Objective
Derivatives market assist 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. Given the changing market dynamics in equity derivatives segment in recent years with increased retail participation, offering of short tenure index options contracts and heightened speculative trading volumes in index derivatives on expiry date, this consultation paper seeks to introduce measures to enhance investor protection and promote market stability in derivative markets, while ensuring sustained capital formation.
Key Changes Proposed
- Increase in Minimum Contract Value from current current size is ₹5 lakh to ₹10 lakh to ₹15 lakh to ₹20 lakh which could increase to up to ₹30 lakh after six months.
- Limiting Strike Prices to 50 strikes for an index derivatives contract at launch to prevent scattering of trading activity and liquidity.
- The strike price is the pre-determined price at which the buyer and seller of an option agree on a contract or exercise a valid and unexpired option.
- Members to collect option premiums upfront from clients.
FAQs
What is the purpose of SEBI's consultation paper on index derivatives?
SEBI’s consultation paper aims to gather feedback on proposed measures to enhance the framework for index derivatives. The goal is to improve market efficiency, transparency, and investor protection in the trading and management of index derivatives.
What are index derivatives?
Index derivatives are financial instruments, such as futures and options, that derive their value from an underlying stock market index. They allow investors to hedge against or speculate on movements in the index without directly buying the constituent stocks.
What are some key measures proposed in the consultation paper?
Key measures include improving liquidity in index derivatives, enhancing risk management practices, increasing transparency in trading, and ensuring more robust settlement processes. Specific proposals may also address margin requirements and position limits.