As the new eligibility criteria for the entry of single stock derivatives will be notified soon, the good news is that none of the stocks in Sensex and Nifty will go out of the futures and options (F&O) list. The SEBI note, viewed by Zee Business, categorically states that none of the existing stocks is part of the Nifty50 and Sensex Indices. In the same note, SEBI has assessed, based on data from May 2024, that 26 stocks from the existing 182 stocks will exit from the F&O segment and 35 new stocks will enter the segment. So, effectively, the total number of stocks in the F&O segment will go up to 191.

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SEBI's board has recently approved the revised criteria for the entry and exit of single stocks in the F&O segment, including the market wide position limit (MWPL) of Rs 1,500 crore against the existing Rs 500 crore, the average daily delivery value of Rs 35 crore in contrast to the existing Rs 10 crore, and a median quarter sigma order of Rs 75 lakh, three times the current Rs 25 lakh. SEBI has also implemented a Product Success framework for single stock derivatives, which was earlier limited to index derivatives only.

No abrupt exit of stocks from F&O

According to the SEBI note, the proposal received little resistance on two issues in the consultation paper. The first was about revision in criteria related to average daily delivery volume, where the concern was: What will happen when market growth consolidates in the coming years, and whether the values of market parameters will be consistent in all periods? So the steep hike in average daily delivery volume criteria for exit based on cash market performance should be moderated. SEBI fixed the average daily delivery volume at Rs 35 crore, in tandem with its earlier proposal to increase it from Rs 10 crore to Rs 30-40 crore.

On this concern, SEBI said that the value ranges of the criteria proposed were arrived at in light of growth witnessed in broad market parameters to ensure that only stocks with sufficient market depth and liquidity are allowed to trade in the derivatives segment. The criteria for entry is based on the average values over six months and similarly, the criteria for exit is also based on average values over three months. Therefore, any abrupt entry or exit of stock to or from the derivatives segment, based on the short-term movement in the underlying market, is prevented.

Public feedback said derivatives are used to hedge losses during event days. If existing stocks are removed from the derivatives segment, the losses might go up. SEBI clarified that if an underlying stock fails to meet the eligibility criteria for three months or if derivatives of a stock fail to meet the criteria laid down under the Product Success Framework (PSF), the stock will exit from the F&O segment. While no new contracts will be issued on the said stock, the existing unexpired contracts may be permitted for trade till expiry and new strikes may also be introduced in the existing contract months. Therefore no abrupt removal of derivatives contracts from a particular stock is expected.
 
SEBI has also clarified that for existing stocks in the derivatives segment, the exit criteria based on performance would be applicable for three months after the date of issuance of the circular. The criteria for exit shall apply to only those stocks that have completed at least six months from the month of entry into the derivative segment. Also, the Product Success framework will apply six months from the date of issuance of the circular by SEBI.

Product success framework to ensure no manipulation

The other concern was about the implementation of a product success framework for single stock derivatives. Public feedback sought dilution of the same.

SEBI said that the PSF criteria for stock derivatives deal with the chances of manipulation in a stock due to the low liquidity of a stock in its derivatives segment, which can be much higher than in index derivatives which are based on a basket of underlying. Unlike index derivatives, stock derivatives are physically settled, which raises the concern of spillover in its cash segment. Therefore, a cautionary approach is warranted while considering liquidity metrics on derivatives of a particular stock. Further, PSF is proposed to be applied after a gestation period of six months. Additionally, the PSF criteria have been suitably moderated and the proposal has been revised to make PSF applicable only if the criteria is not met for three consecutive months.

What is the Product Success framework?

The product success framework was implemented first in index derivatives to ensure there is sufficient turnover, open interest, and widespread participation. SEBI has proposed that at least 15 per cent of trading members active in all stock derivatives or 200 trading members, whichever is lower, shall have traded in any derivative contract on the stock being reviewed on an average monthly basis during the review period, Also, trading on a minimum of 75 per cent of the trading days, average daily turnover (futures + options premium) of at least Rs 75 crore, and average daily notional open interest (futures + options notional) of at least Rs 500 crore during the review period.  

Another feedback was that the entry and exit criteria should be reviewed periodically, to which SEBI replied that the last revision of criteria was carried out in 2018. The criteria have been revised from time to time in line with the change witnessed in the market parameters.

The last review was done in 2018 and as per the growth in the market particularly the derivatives segment, SEBI decided to review it. The reason for review, as per SEBI note is, that without sufficient depth in the underlying cash market, sufficient volumes in derivatives markets, and appropriate position limits around leveraged derivatives, there can be higher risks of market manipulation, increased volatility, and compromised investor protection. Given the evolving market context since then, it is proposed to update the framework and criteria accordingly.