Exclusive: SEBI may float consultation paper to deal with F&O frenzy

A committee of market regulator Securities and Exchange Board of India (SEBI) met on Monday to deliberate the proposals suggested by the expert working group (EWG) on equity derivatives. SEBI's Secondary Market Advisory Committee met for almost two hours to discuss the single-point agenda of equity derivatives. After deliberations, the committee agreed to call for broader consultation on the issue via a public consultation paper. Based on the inputs received on the consultation paper, the policies will be framed. As per sources: "SEBI is quite serious on the proposal and may come up with consultation paper as soon as August and if everything goes well, the proposal may be sent to the board meeting expected in September."

As per one person who was part of the committee twin issues of weekly expiry and increasing the lot size were widely discussed. Modalities for increasing the lot size of index derivatives and stock derivatives were discussed at length, and it was mentioned that the same criteria cannot be applied because in stock derivatives there is a delivery condition also. Issues related to algorithm-based trading also came up during the discussion lot size. 

Last month, Zee Business reported that SEBI had formed an expert working group under the chairmanship of former RBI Executive Director G Padmanabhan.  As per reports, the expert working group has suggested seven short-term measures to deal with the derivatives frenzy, including: 

• Rationalising the weekly contracts
• Increasing the contract size
• Upfront premium collection from option buyers
• Removal of Callender spread benefits on expiry day
• Intraday monitoring of position limits
• Rationalising the strike price of underlying assets
• Hike in margin requirement near contract expiry 

The expert working group will now focus on long-term measures including risk metrics and risk architecture of exchange-traded derivatives. 

In recent months, SEBI has been deliberating with lots of ideas to measure as well as control the risk in case of spillover from derivatives to cash.

The ideas so far under deliberation include a Review of the Open Interest Formulation Mechanism as the current one is prone to misuse. So, SEBI is considering the concept of future equivalent open interest or FutEQ OI, where the delta (unit change in the underlying) adjusted open positions across Futures and Options will be considered across portfolios and exchanges will share the FutEQ OI data like the existing OI. 

Similarly, the rescaling of the Market Wide Position Limit (MWPL) on account of Fut EQ OI is also under consideration. FutEQ OI is generally expected to be less than Notional OI. SEBI believes this will create room for more positions within the existing limit. MWPL is linked to the free float of shares and is limited to 20% of the number of shares on a free float basis.

Restricting Overheating in Derivatives with Linkage to Cash Volume, SEBI is also thinking of linking FutEQ OI with Average Daily Delivery Value (ADDV) in the cash market. SEBI believes the underlying cash market should have sufficient liquidity compared to the open position in the derivatives segment so that any shock of excess demand or excess supply can be absorbed. Also, positions created in the derivatives segment should have an in-built mechanism to slow down further position building.

Relooking the Intraday MWPL Monitoring Mechanism, SEBI may also come up with an intra-day monitoring mechanism of MWPL, as per the existing practice combined open interest is computed at the end of the day,  across exchanges and clearing corporations to check if it is breached or not. SEBI is of the view that Fut EQ OI intraday should be monitored 4 times a day along with risk computation measures.

Fixing Individual Positional Limits for Single Stocks

The regulator is also discussing the idea of a Review of Individual Position Limits for Single stocks. SEBI is concerned that in case of high MWPL but less OI, there is a scope of concentration of open positions with single or few entities. SEBI is considering the idea of linking the position limits in Single stocks to total OI in the scrip across all exchanges.

SEBI's main concern is with respect to the volume of options. The options premium volume including stocks and index has been increasing over the years but the significant jump came after COVID-19. In 2018-19, the options premium volume was around Rs 8.5 lakh crore, which went up to Rs 13 lakh crore in FY20 and Rs 32 lakh crore by the end of FY21, and then more than doubled from there to Rs 69 lakh crore in 2021-22. In FY23, the options premium turnover saw a big jump to Rs 119 lakh crore, and Rs 151 lakh crore the next year.

In a post-board meeting press conference on June 27, SEBI Chairperson Madhabi Puri Buch said that SEBI had noticed the concentration of trading in weekly options and on expiry day, which was driven purely by speculation, not hedging. She said people are borrowing to take such risky bets, which are not contributing to the capital formation in economy.