Type: Prelims Only

Why in the news?

SEBI has proposed a series of measures to curb speculative trading in the index derivatives segment due to concerns over the exponential increase in trading volumes in futures and options, especially among individual investors.

What are the different types of derivatives?  

• Futures: 
• • • Futures are standardized contracts obligating the buyer to purchase an underlying asset (such as stocks, commodities, or currencies) at a predetermined price on a specified future date. They are traded on exchanges, with daily settlements based on market price changes.
    • Futures contracts have margin requirements and are marked to market daily, ensuring liquidity and reducing credit risk.

• Options: 

• • • Options give the buyer the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a predetermined price within a specified time frame. Unlike futures, options are not obligatory; the buyer can choose whether to exercise the option.
    • Options can be traded on exchanges or over-the-counter (OTC) and require the payment of a premium by the buyer.

• Forwards: 

• • • Forward contracts are similar to futures but are privately negotiated agreements between two parties to buy or sell an asset at a future date and price. They are customizable and traded over the counter, which allows for flexibility but introduces counterparty risk.
    • Settlement occurs at the maturity date, and forward contracts do not have standardization like futures.

• Swaps: 

• • Swaps involve the exchange of cash flows or financial instruments between two parties, often based on interest rates or currencies. Common types include interest rate swaps and currency swaps, which allow participants to manage exposure to interest rate fluctuations or gain access to different currencies.
  • Swaps are typically traded over the counter and can be tailored to meet the specific needs of the parties involved.

What measures have the SEBI proposed?

• Increase in minimum contract size for index derivatives from Rs 5-10 lakh to Rs 15-20 lakh, which can be further increased to Rs 20-30 lakh after six months.
• Upfront collection of option premiums by brokers from clients.
• Intraday monitoring of position limits for index derivative contracts by Market Infrastructure Institutions (MIIs).
• Providing only one weekly options contract on a single benchmark index of an exchange.
• Removal of calendar spread benefits on the expiry day for positions involving any of the contracts expiring on the same day.
• Rationalisation of options strikes, with a uniform interval up to a fixed coverage of 4% near the prevailing index price and an increased interval as the strikes move away from the prevailing price.
• Increasing margins on the expiry day and the previous day to address the issue of high implicit leverage in options contracts near expiry.

Why have these measures been proposed?

• The measures aim to enhance investor protection and promote market stability in the derivative markets, amidst concerns about an exponential rise in the volume of trade in the futures and options (F&O) segment, particularly by individual investors.
• In the Union Budget 2024-25, the Securities Transaction Tax (STT) on F&O of securities was doubled to 0.02% and 0.1%, respectively, effective October 1, 2024.
• Data shows that in FY 2023-24, 92.50 lakh unique individuals and proprietorship firms traded in the NSE index derivatives segment and cumulatively incurred a trading loss of Rs 51,689 crore, with only 14.22 lakh investors (about 15%) making a net profit.

Way forward: 

• Enhancing Investor Education and Awareness: To mitigate the risks associated with speculative trading in index derivatives, it is essential to implement comprehensive investor education programs.
• Strengthening Regulatory Oversight and Compliance: SEBI should enhance its regulatory framework by implementing robust monitoring systems that ensure compliance with the proposed measures.