SEBI Considers Stricter Derivative Trading Rules to Manage Explosive Growth in Options Trading

India’s markets regulator, SEBI, is considering a series of adjustments to its derivative trading rules to manage risks from the rapid growth in options trading. Key points include:

1. Proposed Rule Changes:
    – Higher Margins for Options Contracts: SEBI might increase margin requirements for trading options.
    – Detailed Disclosures: Enhanced disclosure requirements for index and stock options contracts are being considered.
    – Linking Options Trading to Cash Volumes: To limit open positions in less liquid stocks, options trading might be linked to underlying cash volumes.
    – Flat Fees for Brokers: Exchanges could be asked to charge flat transaction fees to brokers, regardless of their turnover.
    – Individual Stock Derivatives Rules: Tighter rules for derivatives linked to illiquid stocks may be implemented.

2. Reason for Changes:
    – Retail Investor Participation: Retail investors have driven a significant increase in index and stock options trading.
    – Explosive Growth: The notional value of index options traded in 2023-24 more than doubled to $907.09 trillion.
    – Investor Protection: Concerns about future challenges for markets, investor sentiment, and household finances have been raised.

3. Regulatory and Government Concerns:
    – Excessive Speculation and Manipulation: There is a need for appropriate risk disclosure and measures to prevent excessive speculation or manipulation.
    – Ratio of Options to Cash Volumes: India’s options volumes are roughly four times the underlying cash trading volumes, compared to a global average of 5-15 times. This high ratio is a concern.
    – Zero-Day Expiry Options: There are reservations about introducing zero-day expiry options contracts, as they are seen as purely speculative.
    – Lot Sizes of Options Contracts: Increasing lot sizes may prevent very small investors from entering the market.

4. Market Data and Trends:
    – Global and Indian Trading Statistics: Of the 108 billion options contracts traded worldwide in 2023, 78% were on Indian exchanges. Retail investors account for 35% of derivative trading in India.
    – Retail Investor Activity: In April, 78% of trades on the National Stock Exchange were by investors trading less than 1 million rupees ($11,969).

5. Public Consultation and Implementation:
    – Discussion Stage: The proposed changes are currently in the discussion phase and will be open for public consultation before being implemented.

6. Legal and Foreign Participation:
    – Legal Disputes: U.S.-based firms Jane Street and Millennium are involved in a legal dispute over an India options strategy, with Jane Street claiming significant revenue from the strategy in 2023.
7. Official Comments:
    – Pending Responses: Emails sent to SEBI and India’s finance ministry seeking comments have not yet been answered.

8. Expert Opinions:
    – Will Acworth, FIA: The primary concern for the government and SEBI is investor protection, as buying options without understanding them is akin to gambling.

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