The Securities and Exchange Board of India (SEBI) is considering a series of amendments to its derivatives trading regulations to address risks associated with the rapid growth of options trading, according to Reuters report. This move comes after months of consultations with exchanges, brokers, and fund houses, according to two sources with direct knowledge of the matter.
The proposed changes include higher margin requirements for options contracts and enhanced disclosure mandates. These discussions have been ongoing for the past four months, the sources, who requested anonymity, revealed.
In recent years, India has seen a significant increase in trading of index and stock options, largely driven by retail investors. This surge has prompted warnings from market participants and government officials about potential risks. In the financial year 2023-24, the notional value of index options traded more than doubled to $907.09 trillion.
Finance Minister Nirmala Sitharaman recently highlighted the dangers of unchecked growth in retail trading of futures and options, noting potential threats to market stability, investor sentiment, and household finances.
A regulatory official explained the necessity for proper risk disclosure and measures to curb excessive speculation and possible market manipulation. One proposed measure involves linking options trading to underlying cash volumes in stocks to prevent excessive open positions in less liquid stocks. When options positions significantly exceed cash volumes, margin requirements would be increased, the sources said.
Currently, options volumes in India are approximately four times the underlying cash trading volumes, compared to a global average of 5-15 times. This discrepancy has raised concerns, particularly when contrasted with the US, where the derivatives-to-cash ratio is about nine times.
SEBI is also considering mandating more detailed disclosures on index and stock options contracts, beyond just options activity and open interest. Additionally, the regulator may propose flat fees on brokers regardless of turnover, replacing the current practice of lower transaction fees for high-turnover brokers.
Earlier this month, SEBI suggested tighter regulations for individual stock derivatives, potentially eliminating derivatives linked to illiquid stocks. These proposed changes are still under discussion and will be open for public consultation in the coming months.
Rising Speculation
In 2023, 78 per cent of the 108 billion options contracts traded worldwide were on Indian exchanges, according to the Futures Industry Association (FIA). Retail investors account for 35 per cent of this derivative trading in India. In April, 78 per cent of trades on the National Stock Exchange were by investors trading less than Rs 1 million ($11,969).
This increase in trading volumes has attracted foreign trading firms. US-based Jane Street and Millennium are currently in a legal dispute over India options strategies, with Jane Street claiming it earned about $1 billion in revenues from these strategies in 2023.
Indian exchanges have yet to introduce zero-day expiry options contracts, which are popular in markets like the United States. A source familiar with government thinking indicated that officials are wary of the potential surge in zero-day options trading, viewing it as pure speculation without market benefits.
The government has also suggested SEBI consider increasing the lot sizes of options contracts to prevent very small investors from entering the market.
"The growth rate of options volumes in India is unprecedented," said Will Acworth, senior vice-president of Data & Research at the FIA. "The main concern for the government and SEBI is not the financial system's risk but investor protection," Acworth added, likening uninformed options trading to gambling.