India’s financial market watchdog has suggested more restrictive regulations on individual stock derivative trades, citing the necessity of these measures to mitigate market manipulation risks following a significant increase in options trading.
Following reports from two informed sources to Reuters in April, it was revealed that India’s principal financial authorities are planning to establish a committee to evaluate the potential stability threats posed by the burgeoning derivatives markets.
The past five years have seen a dramatic rise in options trading in India, predominantly driven by individual investors. This surge has led to the notional value of index options trading on the National Stock Exchange (NSE) more than doubling in the fiscal year 2023-24, reaching a staggering $907.09 trillion, up from the previous year.
The Securities and Exchange Board of India (SEBI) released a discussion paper on its website this Sunday, stating that derivatives contracts on individual stocks must exhibit adequate liquidity and attract sufficient trading interest from market participants, a criterion previously applied only to index contracts.
SEBI expressed concerns that without a robust underlying cash market and proper position limits for leveraged derivatives, there could be heightened risks of market manipulation, increased volatility, and jeopardized investor protection.
According to the proposed guidelines, for a stock to qualify for futures and options (F&O) trading, it must have been traded on at least 75% of trading days. SEBI did not clarify the specific timeframe for this requirement.
Furthermore, the proposed criteria include that at least 15% of active derivatives traders should have engaged in trading the stock; the average premium daily turnover should be at least 1.5 billion rupees (approximately $18 million); the average daily turnover should range between 5 and 15 billion rupees; and the maximum allowable open F&O contracts for the stock should be between 12.5 and 17.5 billion rupees. Again, SEBI did not provide timeframes for these conditions.
This regulatory attention arises as India’s leading stock exchanges compete for dominance in the rapidly expanding derivatives market by enticing investors with innovative products and reduced fees, thereby stimulating a spike in trading volumes.
Data from the Futures Industry Association indicates that of the 108 billion options contracts traded globally in 2023, a remarkable 78% were transacted on Indian exchanges. Retail investors account for 35% of the country’s derivative trading.
A research note from the financial services company IIFL suggested that the regulator’s proposed changes could potentially disqualify up to 25 of the 182 stocks currently available for futures and options trading.
The publication of a discussion paper represents the initial action by Indian regulators towards amending policies or regulations.