New F&O Regulations in India: Changes & Impact

In the wake of unprecedented activity in the options market, regulators and the government have shifted their focus to the speculative trades dominating this segment. A staggering 90% of traders reportedly incur losses, prompting a thorough review by regulatory bodies in India, which currently ranks highest in global options trades.

The Securities and Exchange Board of India (SEBI) responded by forming an expert working committee to examine the surge in speculative trading, particularly by retail investors. This committee's insights are now poised for evaluation by the Secondary Market Advisory Committee, setting the stage for potential regulatory adjustments.

Significant Growth in F&O Turnover

SEBI reports indicate a substantial increase in the derivatives market, with overall turnover escalating from Rs 210 trillion in FY18 to Rs 500 trillion in FY24. This period has also seen a significant rise in retail investor engagement in the F&O sector, with participation surging over 40% from 65 lakh investors in FY23 to 96 lakh in FY24. Moreover, the presence of individual investors in index options has seen a dramatic rise from 2% in FY18 to 41% in FY24.

Proposed Regulatory Changes and Their Implications

Increasing Lot Sizes: A Double-Edged Sword

The primary suggestion from the committee is to hike the minimum lot size of derivative contracts from Rs 5 lakh to Rs 20-30 lakh. Such an increase would necessitate traders to provide a larger margin. Specifically, increasing the lot size to Rs 20 lakh could mean a Nifty contract would comprise 80 units as opposed to the current 25, increasing the required margin from approximately Rs 70,000 to about Rs 2.25 lakh.

Increasing the lot size is intended to curb the participation of retail traders in the futures market, although the bulk of the trading activity is observed in the options market. In the options market, where traders predominantly engage in option selling strategies—which requires roughly the same margins as futures contracts—this increase in margin requirements serves as a deterrent for retail participants and could profoundly affect trading volumes.

Restricting Weekly Options: Reducing Trading Volumes

Another significant recommendation is limiting weekly options to a single expiry per week across stock exchanges. Typically, option expiry days see the highest trading volumes. For instance, indices like Nifty, Bank Nifty, Nifty Financial Services, and Nifty Mid-cap Index on the NSE have different expiry days throughout the week, while the BSE's Sensex expires on Fridays.

Reducing the number of expiries to just two per week could potentially halve trading volumes, impacting traders who tailor their strategies to these specific days. This reduction in trading opportunities would not only affect the income streams of exchanges and brokers but also drastically decrease the earning potential for skilled traders. Moreover, the limitation on expiries might not necessarily curb the activities of retail traders, who could opt to place larger bets on the fewer available expiries.

Additional measures being considered include reducing the number of available strike prices, requiring upfront payment of option premiums by buyers, intra-day monitoring of position limits, and an increase in margin requirements as expiry approaches.

The Broader Consequences for Market Dynamics

The increase in lot sizes and restrictive measures might not only deter retail traders but also push them towards unregulated local operators, known as "dabba trading." Such a migration could undermine the structured trading environment and negate the efforts to maintain market integrity.

The stringent constraints might also compel professional traders to explore international markets with more lenient regulations. This shift is particularly concerning at a time when India is actively promoting GIFT City as a global financial hub. Drastic regulatory actions could deter a segment of traders and might be unfavourably perceived by the international financial community, potentially undermining India’s global financial aspirations.

Conclusion: A Delicate Balance for SEBI and the Government

With significant growth in the Indian options market attracting numerous trading firms, overly restrictive measures could send the wrong signals and potentially stifle the industry. Limiting trading options like weekly expiries could severely affect the market dynamics and the livelihoods of those involved. As India strives to position itself as a financial hub, it is crucial for SEBI and the government to maintain a balance that ensures market vitality while considering the broader economic impact.

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