The Securities and Exchange Board of India (SEBI) has introduced a series of regulatory measures aimed at curbing excessive speculation in the derivatives market, particularly in the weekly options segment. These measures are part of a broader effort to protect investors and ensure market stability, as speculative trading volumes in weekly expiries have surged. Below is a detailed breakdown of the key announcements and their impact on traders and brokers.
1. Upfront Collection of Option Premium
From February 2025, SEBI mandates that option premiums must be paid upfront by buyers. While this might sound straightforward, the current practice allows intraday traders to use their broker’s collateral instead of their own funds. This loophole enables traders to take large speculative positions intraday without actually paying the premium.
Brokers provided this facility to certain clients, allowing them to engage in high-volume intraday options trading using another party’s collateral. SEBI’s new rule will close this loophole, requiring traders to pay out of their own capital for all option purchases, thus limiting excessive speculative trades that could destabilize the market.
2. Removal of Calendar Spread Treatment on Expiry Day
Another significant change is the removal of calendar spread benefits on the expiry day. Currently, traders can sell options expiring on a given day and simultaneously buy futures or options with a later expiry (such as weekly options vs. monthly options) to qualify for a “calendar spread” benefit. This reduces margin requirements by as much as 50%, allowing traders to leverage their positions far beyond what their margin would normally permit.
However, SEBI has decided to remove the calendar spread benefit for expiry day positions, meaning that any spread involving contracts expiring on the same day will no longer receive the reduced margin benefit. This rule targets strategies like selling straddles or strangles on expiry day, which many retail traders use to scalp profits. The removal of this benefit addresses the systemic risk that arises when the non-expiring leg of the spread does not move in sync with the expiring leg—especially during market spikes. This change will take effect on February 1, 2025.
3. Intraday Monitoring of Position Limits
Another important measure is the intraday monitoring of position limits. Up until now, exchanges have monitored position limits only at the end of the trading day. However, given the large volumes and potential for excessive position building during the day—especially on expiry day—SEBI will now require exchanges to take at least four random snapshots of traders’ positions throughout the day. This change aims to prevent traders from exceeding position limits during the day, reducing the risk of market manipulation and excessive volatility. This new rule will be implemented on April 1, 2025.
4. Recalibration of Contract Size for Index Derivatives
Finally, SEBI has recalibrated the contract size for index derivatives, increasing the minimum size from ₹5-10 lakhs to ₹15 lakhs, with a cap of ₹20 lakhs. This change, effective November 20, 2024, ensures that only participants with significant capital can engage in these leveraged instruments, thereby reducing the risk for smaller, undercapitalized traders.
5. Rationalization of Weekly Expiries for Index Derivatives
Weekly options expiries have become a hotspot for speculative trading, particularly as traders look to capitalize on short-term price movements with very short holding periods. SEBI has observed that weekly expiries create unnecessary volatility without contributing to long-term capital formation. As a result, SEBI will restrict each exchange to offering weekly expiries on only one benchmark index per exchange, effective November 20, 2024. This move is aimed at reducing the hyperactive trading volumes on multiple weekly expiries, making the market less volatile and more stable.
6. Increase in Tail Risk Coverage on Expiry Day
Given the heightened speculative activity on expiry days, SEBI will impose an additional Extreme Loss Margin (ELM) of 2% on short options contracts expiring that day. This will apply to both existing short positions and any new short positions initiated during the day. The idea is to cover the tail risk (the risk of sudden large moves) that is often magnified on expiry days. This measure will take effect on November 20, 2024, and is intended to reduce the risk associated with last-minute speculative trades.
Impact on Traders
1. Higher Initial Costs:
Traders, particularly retail participants, will now need to pay the full option premium upfront, significantly increasing their initial costs. This change will reduce the use of leverage in the market and might force smaller traders to scale back their positions.
2. Fewer Leverage Opportunities:
With the removal of calendar spread benefits on expiry day, traders can no longer use this strategy to halve their margin requirements. This will limit speculative positions, especially for retail traders who rely on high-leverage strategies like selling straddles or strangles on expiry day.
3. More Cautious Trading:
Intraday monitoring of position limits means traders will have to be more cautious about their position sizes throughout the day. The possibility of penalties for breaching these limits will make intraday trading riskier for aggressive traders.
4. Fewer Expiry Day Opportunities:
The rationalization of weekly expiries limits traders to only one benchmark index per exchange, reducing the number of short-term speculative opportunities. For traders who specialize in expiry-day trades, this reduction could force them to rethink their strategies.
5. Higher Risk on Expiry Day:
The increase in tail risk margin on expiry day will add to the cost of holding short options positions. Traders who rely on shorting options for their strategies will face higher margin requirements, potentially making such trades less profitable.
Impact on Brokers
1. Operational Adjustments for Premium Collection:
Brokers will need to adjust their systems to collect option premiums upfront, which could increase their operational burden. The removal of leverage facilities for intraday options trades may also result in the loss of clients who previously benefited from this practice.
2. Increased Margin Monitoring:
Brokers will now have to recalibrate their margin systems to reflect the removal of calendar spread benefits on expiry day. This will require more complex monitoring of traders’ positions, especially on high-volume days like expiry day.
3. Increased Surveillance and Risk Management:
With the requirement for intraday position monitoring, brokers will need to ramp up their risk management and surveillance systems. This could lead to higher operational costs as brokers will need to invest in technology and processes to ensure they remain compliant with SEBI’s new intraday monitoring requirements. Failure to properly monitor and manage these positions could result in penalties, creating additional risks for brokers.
4. Impact on Trading Volumes:
Brokers who derive a significant portion of their revenue from high-frequency and speculative traders could see a drop in trading volumes. The reduction in opportunities for leveraged trades and the rationalization of weekly expiries may discourage some traders, particularly retail investors who engage in short-term, high-volume speculative trading. This reduction in activity could impact brokers’ commission-based revenue.
5. Higher Risk for Expiry Day Trades:
Brokers will need to factor in the increased Extreme Loss Margin (ELM) on expiry days for short options positions. This may require them to increase margin requirements for clients and could lead to lower levels of participation in the options market on key expiry days. Additionally, brokers will need to ensure that clients meet these higher margin requirements, adding to their risk management workload.
Next Steps for Traders and Brokers
SEBI’s new measures are a direct response to the growing speculative activity in weekly options expiries, and they aim to foster a more stable and risk-aware trading environment. By introducing upfront option premium payments, removing calendar spread benefits on expiry days, and increasing intraday surveillance of position limits, SEBI is reducing the opportunities for excessive speculation.
For traders, especially retail participants, these changes mean higher costs, reduced leverage, and fewer speculative opportunities. While the measures will lead to a more stable market, they may also discourage some retail traders from participating in high-risk, short-term strategies.
Brokers, on the other hand, will face increased operational demands, particularly in the areas of margin collection and position monitoring. The impact on trading volumes and speculative activity could affect their bottom line, but the increased risk controls will ultimately lead to a healthier market environment.
Overall, these measures mark a shift towards more regulated, risk-managed derivatives trading, where both traders and brokers will need to adapt to a less speculative and more capital-intensive environment
