Reduction of Weekly Expiries, Increased Contract Sizes, and Higher Margins: A Game-Changer in India’s Derivatives Market

The Indian derivatives market is set for a significant overhaul starting November 20, 2024, as the Securities and Exchange Board of India (SEBI) introduces sweeping changes to limit speculative trading and enhance market stability. These new regulations target the structure of index derivatives contracts, contract sizes, and margin requirements, which will shape how traders approach the market.

Let’s break down these key developments and their implications.

1. Reduction of Weekly Expiries

SEBI’s new rule will reduce the number of weekly expiries for index derivative contracts to one per benchmark index per exchange, a notable shift from the current system, which allows for 18 weekly contracts each month. Going forward, exchanges will offer only six weekly contracts.

Why this change? The rationale behind this move is to curb speculative trading, which has become more rampant with the availability of frequent expiries. Frequent expiries often result in traders taking aggressive short-term positions, particularly in uncovered or naked option selling—where the seller doesn’t own the underlying asset. This poses significant risks, especially in volatile markets. By limiting the number of weekly contracts, SEBI aims to discourage such behavior and ensure more thoughtful, long-term participation in the derivatives market.

Implications for traders:

• Speculative traders: Those who rely heavily on weekly expiries to engage in short-term trades will likely need to adjust their strategies. With fewer expiries available, they may need to adopt longer-term positions or move to alternative trading strategies.
• Market stability: The reduced expiries are expected to stabilize market behavior, especially around expiry days, when high volatility is often observed due to last-minute position unwinding.

2. Increased Contract Sizes

In a bid to ensure that investors take on appropriate risks, SEBI will also increase the minimum trading amount for index derivative contracts. The current range of Rs 5–10 lakh will be revised to Rs 15 lakh, and SEBI has announced plans to further adjust the contract value to between Rs 15 lakh and Rs 20 lakh.

The logic behind larger contract sizes: SEBI aims to align the contract sizes with the principle of responsible investing. By raising the minimum contract size, the regulator hopes to deter smaller, risk-prone investors from engaging in highly leveraged positions that could expose them to outsized losses. The revised contract size is also designed to attract more sophisticated and well-capitalized investors who are better equipped to manage the risks associated with derivatives trading.

Impact on market participants:

• Retail investors: Retail traders with limited capital may find it harder to participate in the derivatives market unless they trade through mutual funds or other investment vehicles. This change will likely push some retail traders out of the market or encourage them to shift to alternative asset classes.
• Institutional investors: The increased contract sizes will favor institutional investors, who have the financial resources and risk management expertise to handle larger trades. This could lead to a more professionally-driven market, with fewer retail participants engaging in speculative activity.

3. Higher Margin Requirements

To tackle the high volatility that is often seen on expiry days, SEBI will introduce an additional extreme loss margin (ELM) of 2% for all open short options on expiry day. This is designed to provide an extra layer of protection for investors against sudden, sharp market movements that can occur during high-volume trading sessions.

Why the new margin requirement? Expiry days are notorious for heightened market volatility, as traders rush to close or roll over positions. This can lead to extreme price swings, especially in cases where traders are caught off guard by market movements. The additional ELM is intended to buffer against such events, ensuring that investors maintain sufficient margins to cover potential losses, particularly for short options, which carry unlimited risk.

Effects on trading behavior:

• Short sellers: Investors engaging in naked short selling will face higher margin requirements, forcing them to be more cautious and potentially reducing the volume of uncovered options trading.
• Market volatility: By requiring higher margins, SEBI hopes to dampen the sharp volatility spikes often observed on expiry days, creating a more orderly and predictable market environment.

The Bigger Picture: Curbing Speculation, Promoting Stability

The collective impact of these changes is clear: SEBI is sending a strong signal that the Indian derivatives market must evolve towards a more disciplined and risk-conscious environment. By reducing the number of expiries, increasing contract sizes, and implementing higher margins, SEBI is aiming to strike a balance between encouraging healthy market participation and curbing excessive speculation.

What to watch for:

• Shift in market dynamics: As retail investors and speculative traders are sidelined, we may see a shift towards a more institutionalized market with a greater emphasis on risk management and long-term strategies.
• Market liquidity: Reduced speculative activity could impact liquidity in the short term, but it could also lead to a more stable and resilient market over the long term.
• Investor sentiment: While the changes might initially unsettle some market participants, especially those accustomed to high-frequency, short-term trades, these reforms are likely to foster a more sustainable and transparent derivatives market.

Conclusion

SEBI’s new regulations mark a pivotal moment for India’s financial markets. By reducing weekly expiries, raising contract sizes, and introducing higher margin requirements, the regulator is aiming to create a safer, more stable market environment. For traders and investors, this is a time to reassess strategies and adapt to a more disciplined and risk-aware market structure.

These reforms will have far-reaching consequences, potentially reducing speculative activity and fostering a derivatives market that emphasizes sustainability and prudence over short-term gains. As November 2024 approaches, market participants should prepare for a new era in derivatives trading.

source : SEBI India