Here are 10 things Sebi’s latest consultation paper titled ‘Enhancing Trading Convenience and Strengthening Risk Monitoring in Equity Derivatives’ proposes to do:
1) Computation of OI
Sebi is mulling changing the methodology for the calculation of open interest (OI) from the current notional terms to ‘Future Equivalent’ or Delta-based approach.
Open Interest (OI) in derivatives markets represent the total outstanding position held by all participants. Currently, OI is calculated by adding open interest of futures and options (in notional terms) for each investor.
The objective behind moving to a Future Equivalent (FutEq) or Delta-based OI approach is to address the limitations of notional-based OI, particularly its lack of meaningful aggregation across futures and options. A purely notional approach is susceptible to manipulation like artificially pushing a stock into the ban period or obscuring the true risk exposure of certain positions.
Meanwhile, the Delta-based OI computation approach will allow for combining the OI from futures (where Delta = 1 times the notional for long futures) and from options (where Delta ranges from –1 to +1 times the notional) to reflect the overall price sensitivity (FutEq OI) in the derivatives market for a given underlying.Sebi is of the view that this methodology could provide a more accurate snapshot of the exposure at a particular time and aligns more closely with the cash market activity in terms of trading volumes and deliveries.
2) Reducing Artificial Ban Periods
The consultation paper proposes to reduce the artificial ban period for single stock futures. Transitioning to Delta-based OI could reduce this possibility by counting only the effective exposure of these out-of-money positions at a point in time.
A stock is placed in the ban period when combined OI reaches 95% of the Market Wide Position Limit (MWPL). Under a notional approach, participants could potentially take large notional positions in options with minimal Delta risk at a point in time (e.g., deep out-of-the-money options) to push the combined OI close to the MWPL and trigger a ban.
After back testing for July 1, 2024 to September 30, 2024, Sebi found that under the current MWPL rules, there were 366 separate instances of stocks entering the ban period. Under the proposed formulation, these instances will drop to 27, which could be a 90% reduction. This approach would reduce artificial pushes into the ban period and also make such manipulation more difficult.
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3) Calibration of MWPL
Sebi has proposed that the MWPL for single stocks be set as the lower of 15% of free-float market capitalisation or 60 times the Average Daily Delivery Value, (ADDV), in the cash market across exchanges. This metric will be recalculated every three months based on the rolling ADDV for the preceding three-month period.
There is a proposal for CCs to perform intraday monitoring at least four random times during the trading session to safeguard market integrity and limit settlement risk from intraday spikes in FutEq OI.
4) Mitigating potential manipulation
Tying the MWPL to cash market delivery volumes will reduce potential manipulation and better align derivatives risk with the underlying cash market liquidity.
5) MWPL for index derivatives
Sebi will separately and subsequently explore the need for an MWPL for index derivatives, in consultation with market participants, to ensure market integrity and prevent excessive volatility. Under current norms, the index derivatives are cash-settled and presently do not have an MWPL.
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6) Reducing FutEq OI
During the ban period, any new trade will be permitted only if it reduces the participant’s starting FutEq OI for that day. For example, a holder of a long futures position could buy put options or sell call options to reduce total Delta exposure.
7) Broker System Check
A mechanism would be built into brokers’ trading software to ensure compliance with these rules, i.e., to confirm that any new trade during the ban period decreases the participant’s net Delta exposure in that scrip.
8) Computation of exposure limits for Mutual Funds and AIFs in derivatives
For futures exposure, no change in how futures exposure is computed for single stocks and indices is proposed, since notional values for long futures already align with their FutEq (Delta = 1 times notional). Both long and short options to be measured on a FutEq (Delta) basis, capturing their real price sensitivity at a point in time rather than just premium outlay.
9) Pre-Open and Post-Closing sessions for the derivatives market
It is proposed to extend pre-open and post-closing sessions to current-month futures on both single stocks and indices, mirroring the modalities of the cash market’s pre-open and post-closing sessions.
While pre-open and post-closing sessions already exist in the cash market, extending these to futures could improve alignment between the two segments and enhance price discovery.
10) Eligibility criteria for derivatives on non-benchmark indices
Sebi has proposed additional criteria for introducing derivatives on non-benchmark indices. Under this a minimum of 14 constituents would be required. The top constituent’s weight will be less than or equal to 20%. Moreover, the combined weight of the top three constituents should be less than or equal to 45%. All other constituents’ individual weights must be lower than those of the higher-weighted constituents.
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