Market regulator Securities and Exchange Board of India (SEBI) is considering further measures to deal with the Futures and Options (F&O) frenzy. SEBI recently floated a consultation paper based on the recommendations of an expert working group, which suggested seven short-term measures to curb the speculation activity in equity derivatives, now the focus is on the medium-term policy measures.

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Zee Business has learnt that after a 'seven-sutra' strategy for the short term, and the medium-term strategy may have five additional sutras. In fact, with this 'five-sutra' strategy, the overall way of measuring activity in the equity derivatives will change. The strategy is based on the advice of the working group report, comprising exchange and clearing corporation officials. It’s expected that SEBI may request the expert working group to consider the report in formulating the medium-term measures.

Here's what the five sutras include:   

Review of Formulation of Open Interest

Of the five Sutras that SEBI is considering is changing the way Open Interest (OI) is formulated. SEBI plans to come up with the idea of Future Equivalent Open Interest (Fut EQ OI), which will give a sense of inbuilt risk based on volatility in the derivative positions. 

'Future Equivalent' refers to the number of future contracts necessary to hedge an equivalent position. It is calculated by aggregating change in price (delta) associated with the position.

The existing formulation of OI doesn’t give a meaningful measure of market risk because it does not give much information about the risk undertaken by the participants, and is just a composite measure of the participant’s activity. Also, the existing mechanism has scope for misuse, if few participants can take large Out of the Money (OTM) positions in a scrip, which has a combined Open Interest close to MWPL, the stock may be pushed in a ban period. After discussion with exchanges, NSE has started sharing this Fut EQ data from October last year. 

ALSO READ: Sebi proposes tighter index derivatives norms to protect households against harsh realities of F&O trading

Rescaling of MWPL on account of Fut EQ OI

The second sutra is the rescaling of Market Wide Position Limit (MWPL) based on Fut EQ OI. As FutEQ OI is generally expected to be less than Notional OI, SEBI is likely to propose a study-based limit for MWPL based on the relation between FutEQ OI and Notional OI for a period of 3-6 monthly expires, Then, the existing MWPL could be scaled down by the said ratio for the next expiry. For example, a Fut EQ OI of 20 per cent means that the free float of a scrip is 20,00,000. On average, for the last six months, FutEQ OI is 50 per cent of the Notional OI. In that case, the MWPL for the next expiry would be 10,00,000.

Restricting Overheating in Derivatives with Linkage to Cash Volume

SEBI is also thinking of linking FutEQ OI with Average Daily Delivery Value (ADDV) in the cash market. SEBI believes that the underlying cash market should have sufficient liquidity compared to the open position in the derivatives segment so that any shock of excess demand or excess supply can be absorbed.

If FutEQ OI in any scrip starts to become very high as compared to the cash market, it may have the risk of spillover from the F&O to the cash market. Assuming the Fut EQ is greater than the 30-day cash market volume at the end of the day, a 10 per cent spillover in the cash market will lead to additional demand or supply equivalent to three days of delivery hitting the cash market. So, for positions created in the derivatives segment, a condition may be imposed to have an in-built mechanism to slow down further position building.

Relooking Intraday MWPL Monitoring Mechanism

As per the existing practice, the combined open interest is computed at the end of the day across exchanges and clearing corporations to check whether it is breached. SEBI is of the view that Fut EQ OI should be monitored four times a day along with risk computation measures. In the past, there have been incidents of MWPL breaching the trigger of 95 per cent by the end of the day and leading to a scrip going into a ban.

Fixing Individual Positional Limits for Single Stocks

Individual Position Limits for single stocks may also be reviewed. SEBI is concerned that in case of high MWPL but less OI, there is scope of concentration of open positions with single or few entities. As the positions are monitored by clearing corporations at the end of the day, there can be a possibility of an entity taking multiple positions through different clearing members of different clearing corporations beyond the limit.

Hence, to deal with this issue, SEBI is considering the idea of linking the position limits in single stocks to total OI in the scrip across all exchanges.

SEBI may fix the OI limit for clients at 15 per cent 25 per cent for brokers, FPIs, and MFs. In a passive breach, there will be a leeway to run until expiry. Currently, the position limit for brokers/Cat 1 FPIs and MFs is 20 per cent of MWPL, and for clients, it's the higher of 1 per cent of the free float or 5 per cent of the OI in the scrip. Fixing the limit for FPIs may be a big challenge.
 
Recently, SEBI Whole-time Member Ananth Narayan G hinted at the new measures in his speech at FICCI CAPAM. “The way we measure positions in the case of F&O is based on nationals added across futures and options, which does not make sense. We are trying to see if we can move to a future equivalent or delta equivalent measure," he said. 

According to people aware of the development, new measures to assess risk in the F&O activity have been in deliberation for the last one year. The idea was to come up with a medium-term strategy but the rising volumes and concerns expedited the whole process and SEBI had to form an expert working group to suggest immediate measures as well as medium and long-term measures.

After expert working group recommendations, SEBI has proposed seven measures including the rationalization of options strikes, upfront collection of options premium, Removal of calendar spread benefit on expiry day, Intraday monitoring of position limits, Increasing the minimum contract size, and rationalising of weekly options.