SEBI Brings New Rules to Restrict Entry in F&O Trading

Entry in F&O Trading becomes tougher due to SEBI's new RulesThe Securities and Exchange Board of India (SEBI) last week tightened the norms for futures and options (F&O) trading by raising the entry barrier and making it more expensive for retail investors to trade in F&Os. In this article, we look at all the details.

SEBI's New Rule on Entry of F&O Traders & Its Effective Date

Here is an overview of the new rules and the timelines of their effective date. As you can see, the first two changes regarding contract size and weekly expiries will be effective from November 20, 2024. Some changes will be implemented by February 1, 2025.

Detailed Explanation of the new F&O Trading Entry Framework

Here are all the rules with details and explanations:

Increased Contract Size for Index Derivatives: SEBI's recent decision to increase the contract size for index derivatives from Rs 5-10 lakh to Rs 15-20 lakh has significant implications for the F&O market. The higher entry barrier could help to curb speculative trading and promote a more orderly market.

Rationalization of Weekly Index Derivatives Products: SEBI has decided to reduce the number of weekly expiry options for index derivatives is aimed at curbing excessive speculation and promoting market stability. SEBI has decided that each exchange (NSE and BSE) can only offer weekly derivatives contracts for one of its benchmark indices.

Upfront Collection of Option Premium: SEBI is also implementing a new rule that requires brokers to collect the full option premium upfront from buyers. Currently, some brokers allow traders to use leverage through cover orders, which reduces the upfront cost of purchasing options.

Increase in Tail Risk Coverage on Expiry Day: To manage the intense volatility that often occurs on options expiry days, SEBI has introduced an extra margin requirement known as the "extreme loss margin." This will raise the margin requirements for option sellers by 2% on expiry days, adding a layer of protection against sharp price swings.

Intraday Monitoring of Position Limits: Currently, SEBI monitors position limits for index derivatives at the end of each trading day. This ensures that no single broker exceeds a certain percentage of the total open interest (OI) in the market. The new rule introduces intraday monitoring, where brokers' positions will be checked at four random intervals throughout the day.

Removal of Calendar Spread Treatment on Expiry Day: The final rule eliminates the margin benefit for calendar spreads on expiry days. A calendar spread involves holding both long and short positions in contracts with different expiration dates. In the past, traders enjoyed a margin reduction for these positions on expiry day, but going forward, this benefit will no longer apply.

Impact on Traders

Below are some of the impacts of the changes on the traders:

• Higher Initial Investment: The increased contract size means that traders will need to invest more capital to enter the market. It could deter smaller retail investors and limit participation. For example, for option buyers, if they were previously required to pay Rs 625 to enter a contract, they will now need to pay around Rs 1,625.
• Reduced Trading Opportunities: With fewer weekly expiry options available, traders will have fewer opportunities to engage in short-term speculative strategies.
• Increased Uncertainty: The increased frequency of monitoring introduces more uncertainty for traders, as they may need to constantly monitor their positions and adjust their strategies to avoid exceeding the limits.

Impact on Brokers

Below are some of the impacts of the changes on the brokers:

• Increased Margin Requirements: Brokers will likely require higher margin deposits from traders to cover the increased risk associated with larger contract sizes. This could further limit the ability of some traders to participate.
• Potential Loss of Clients: Some traders may choose to switch to brokers (upfront collection of option premiums) that allow leverage or trade in other markets with less restrictive rules.
• Increased Compliance Burden: Brokers will have to invest in technology and resources to monitor their clients' positions in real-time and ensure compliance with the new regulations.
• Impact on Brokerage Revenues: The reduction in trading activity could affect brokerage revenues, as brokers earn commissions on each trade.

Before you go

SEBI's new F&O trading rules mark a significant departure from the previous regulatory landscape. While aimed at promoting market stability and investor protection, these changes present challenges for traders, especially retail participants.

As the implementation dates draw near, traders must stay abreast of these developments and adjust their strategies accordingly. The financial community will undoubtedly engage in discussions and debates regarding the potential implications of these changes.

Ultimately, the long-term impact of these rules will depend on how traders and brokers adapt to the new environment. Flexibility, adaptability, and a deep understanding of the market will be key to navigating these changes successfully.