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SEBI Weighs Stricter Derivative Trading Rules Amid Soaring Options Market

Published 19-06-2024, 08:11 am
© Reuters.

The Securities and Exchange Board of India (SEBI) is contemplating significant changes to derivative trading regulations in response to the rapid surge in options trading, according to sources cited by Reuters. These potential revisions aim to mitigate the risks associated with this explosive growth by introducing higher margins for options contracts and enhancing disclosure requirements.

Over the past four months, SEBI has conducted multiple meetings with stock exchanges, brokers, and fund houses to address these concerns. One key measure under consideration is linking options trading with the underlying cash volumes of stocks. This approach aims to limit the accumulation of open positions in less liquid stocks. If options positions excessively exceed cash volumes, the margin requirements for trading options would increase, thereby curbing speculative build-up.

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India’s options trading volumes are currently about four times the underlying cash trading volumes, compared to the global average of 5-15 times. This disparity has raised alarms among regulatory officials, who see it as a potential risk factor. In the United States, for example, the derivatives to cash ratio stands at approximately 9 times.

SEBI is also exploring the possibility of requiring more detailed disclosures for index and stock options contracts. Presently, only options activity and open interest are disclosed, which may not provide sufficient transparency. Furthermore, the regulator is considering a shift in how exchanges levy transaction fees on brokers. Instead of the current practice, where brokers with higher turnover pay lower fees, SEBI proposes a flat fee regardless of turnover.

Earlier this month, SEBI suggested stricter rules for individual stock derivatives. These rules aim to eliminate derivatives linked to illiquid stocks, thus enhancing market integrity. These proposals are still in the discussion phase and will undergo public consultation before implementation.

The surge in options trading has predominantly been driven by retail investors. In the financial year 2023-24, the notional value of traded index options more than doubled to $907.09 trillion. This rapid increase has prompted warnings from market participants and government officials about the potential long-term challenges for the market and investors. The federal finance minister recently highlighted the need for proper risk disclosure to prevent excessive speculation and possible market manipulation.

A significant concern for SEBI is the rise in retail investors engaging in options trading without fully understanding the risks, akin to gambling. Data from the Futures Industry Association (FIA) shows that 78% of the 108 billion options contracts traded globally in 2023 were on Indian exchanges, with retail investors constituting 35% of this trading activity.

Additionally, as per a source, the Indian government has expressed reservations about the introduction of zero-day expiry options contracts, which allow traders to buy options that expire on the same day. Such products are popular in markets like the United States but are viewed as purely speculative by Indian officials.

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