On Tuesday, the Securities and Exchange Board of India (SEBI) took significant steps to implement six out of seven recommendations proposed by an expert panel aimed at cooling the exuberance in India's derivatives market. This market has seen countless investors chase easy money, often resulting in substantial losses. Market experts predict that these new measures could lead to a 20-30% reduction in derivatives trading volumes, underscoring the regulator's intent to protect retail investors from excessive risk.

The first major change is the reduction of weekly expiries per exchange from five to just one. This alteration is set to take effect on November 20, and market participants have mixed opinions about its potential impact. While R. Venkataraman, chairman of IIFL Securities, believes this change will significantly moderate volumes, Dhiraj Relli, MD & CEO of HDFC Securities, suggests that trading volumes from other weekly products will likely shift to the single chosen expiry by the NSE and BSE, presumably for Nifty and Sensex options.

Another impactful change is the increase in lot sizes, which will rise from ₹5-10 lakh to ₹15-20 lakh. This measure is also scheduled to be implemented on November 20. With the value of lot sizes increasing approximately two to three times, traders who previously sold nine options will now only sell three due to the higher margin requirements. For instance, the margin required to sell one Nifty futures or options contract is currently ₹75,000-1 lakh, but this will increase proportionately with the new lot sizes. This increase is expected to temper the sale of index options and futures contracts.

Additionally, the removal of the calendar spread benefit on expiry day will take effect on February 1, 2025. This change is significant, as it previously allowed clients to sell Nifty or Sensex options without sufficient margin by simultaneously buying the same options for the next expiry, effectively creating a hedged position. The elimination of this benefit aims to mitigate systemic risks associated with sudden market movements on expiry days.

Furthermore, the circular from SEBI comes on the heels of a 60% increase in securities transaction tax for derivatives, which could further deter retail participation. Under the new rules, buyers of options are required to pay premiums upfront rather than at a later date, a move aimed at improving market transparency.

A proposed measure related to tail risk has been diluted; initially, it recommended raising the extreme loss margin (ELM) by 3% the day before expiry and 5% on the day of expiry. However, it has now been adjusted to a 2% increase on expiry day. This means that the total margin for futures and options trading will see a rise of 14% on the day of expiry rather than the originally suggested 20%.

The new rules will also include monitoring of position limits to prevent brokers from granting clients excessive leverage during intra-day trading of options or futures. This approach aims to maintain systemic stability and prevent significant market disruptions.

The need for these reforms is underscored by a recent SEBI study indicating that 93% of over 10 million individual F&O traders have, on average, lost ₹2 lakh each (totaling ₹1.8 trillion), inclusive of transaction charges, in the three years leading up to FY24. Alarmingly, more than 75% of these traders reported an annual income of less than ₹5 lakh during FY24, yet they continued to trade in F&O, highlighting a critical need for protective measures.

While these steps are aimed at curbing excessive retail participation and protecting investors, market experts believe that more regulations could be forthcoming, including a potential product suitability framework that sets income or net worth thresholds for trading in derivatives.

These measures, though significant, are not the end of efforts to regulate the derivatives market, and their full impact on market dynamics remains to be seen.

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