By Venkatachalam Shunmugam and Rachana Baid 

The markets regulator has proposed steps to address retail traders’ speculative trading activities, particularly in the context of increased retail participation and the proliferation of short-duration index options contracts. Venkatachalam Shunmugam and Rachana Baid explain how these measures will help stabilise the derivatives market

l  Rationalisation of strike prices

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The rationalisation of strike prices will limit the number of options strikes introduced at any given time, limiting them close to the prevailing index level. This is intended to prevent liquidity scattering and reduce the possibility of artificial trades in illiquid strikes that have the possibility of attracting gullible retail traders. It will make the market more stable and less prone to sudden price movements.

Collecting options premium upfront

Brokers will be mandated to collect options premiums upfront from the buyers when they place their orders. This aims to avoid undue intraday leverage and ensure that all positions are adequately collateralised to the last mile, helping maintain market integrity. It will also reduce default risk.

Change in minimum contract size

The minimum contract  size for index derivatives will be increased in phases. Initially, it will be Rs 15 lakh-Rs 20 lakh, and after six months, it will be raised to Rs 20 lakh- Rs 30 lakh. This change aims to align with the growth in benchmark indices, reduce implicit leverage, and enhance market stability by ensuring that participants are better capitalised and can manage the risks associated with trading in derivatives.

Removing calendar spread benefit on expiry

The calendar spread benefit on expiry day is being removed to address the significant basis and liquidity risks that have been observed on the expiry days. This measure aims to reduce the speculative trading activity that typically occurs around contract expiry, thereby enhancing market stability and reducing risk for all market participants.

Rationalising weekly index products

SEBI proposes to limit weekly options contracts to a single benchmark index per exchange to reduce speculative trading. The existing practice of having weekly expiries on multiple indices across multiple trading days has led to increased speculative activities, particularly around contract expiries.

Intraday monitoring of position limits

Position limits are risk management tools that prevent market concentration and the associated volatility. Intraday monitoring will ensure traders do not exceed their permissible position limits. This will help prevent market manipulation and excessive speculative activities, ensuring an orderly market.

Increase in margins near contract expiry

Margins have only been proposed to be increased on the day before expiry and on the expiry day itself. The Extreme Loss Margin (ELM) will be raised by 3% at the start of the day before expiry and by an additional 5% on the expiry day. This measure aims to address the high implicit leverage and increased risk near contract expiry, ensuring that traders maintain adequate collateral.

Impact on volatility during last half-hour of trading on expiry days

The proposed measures such as the rationalisation of strike prices and the increase in margins near contract expiry, are designed to reduce the speculative hyperactivity that causes increased volatility during the last half-hour of trading on expiry days. By limiting the number of available strikes and ensuring that all positions are adequately collateralised, proposed measures aim to create a more stable trading environment, thereby mitigating the extreme price movements typically observed during this period.

How will these help curb instances of retail investors incurring huge losses?

The measures are aimed at enhancing investor protection. The upfront collect-ion of options premiums, hike in the ELM and removal of calendar spread benefits on the expiry day aim to curb excessive speculative trading. Rationalising the weekly index products will help mitigate the risks that lead to significant losses for individual investors. These measures are intended to create a fairer market, reducing the likelihood of heavy losses for gullible retail participants.

Venkatachalam Shunmugam is a partner at MCQube, and Rachana Baid is the Dean (Academics) at the National Institute of Securities Markets. (Views are personal)