SEBI Suggests Strict Criteria for Stock Derivatives: Comments Invited till June 19
Table of Contents
Introduction
The Securities and Exchange Board of India (SEBI) has proposed an update to the framework governing trading in stock derivatives. In a consultation paper published on its website, SEBI highlighted potential risks such as manipulation of market, increased volatility, and investor protection. The paper invites comments on the eligibility criteria for the entry and exit of stocks derivatives, reflecting the need to maintain market integrity and protection of investors.
Background
Current Criteria of Stock Derivatives
Derivatives contracts allow investors to speculate on the future price movements of an underlying asset, a stock. They are traded on recognized stock exchanges only if the stocks meet the specified criteria, which were last reviewed in 2018 and include:
- Top 500 Stocks: The stock must be among the top 500 in terms of Average Daily Market Capitalization and Average Daily Traded Value (ADTV) on a rolling basis.
- Median Quarter-Sigma Order Size (MQSOS): The stock’s MQSOS over the last six months, on a rolling basis, must not be less than ₹25 lakh.
- Market Wide Position Limit (MWPL): The MWPL in the stock must not be less than ₹500 crore on a rolling basis.
- Average Daily Delivery Value (ADDV): The ADDV in the cash market must not be less than ₹10 crore on a rolling basis.
These criteria must be fulfilled continuously for six months. If a stock fails to meet these criteria for three consecutive months, it will exit the derivatives segment, although existing unexpired contracts can continue trading until expiry.
Rationale for the Update
The existing criteria aim to ensure that only stocks meeting certain size and liquidity benchmarks in the underlying market are eligible for derivatives trading. However, since the last review in 2018, market conditions have evolved, necessitating an update to the framework to address new challenges and opportunities.
Current Updates
SEBI’s consultation paper proposes several adjustments to align the eligibility criteria with current market conditions and growth. Key proposals include:
- Trading Frequency: The stock must have traded on 75% of trading days.
- Trader Participation: At least 15% of active traders or 200 members, whichever is lower, must have traded the stock.
- Average Daily Turnover: The average daily turnover should be between ₹500 crore and ₹1,500 crore.
- Average Premium Daily Turnover: The average premium daily turnover should be at least ₹150 crore.
- Open Interest Increase: The maximum number of open contracts allowed for the underlying stock should be increased to between ₹1,250 crore and ₹1,750 crore.
- MQSOS: The stock’s MQSOS over the last six months should be between ₹75 lakh and ₹100 lakh, increased from a minimum of ₹25 lakh.
- ADDV: The stock’s minimum rolling average daily delivery value in the cash market over the previous six months should be ₹30-40 crore, (from ₹10 crore).
Product Success Framework (PSF)
SEBI also proposes to introduce a Product Success Framework (PSF) for stock derivatives, similar to the framework already applied to index derivatives. This framework would ensure that derivatives contracts on individual stocks have sufficient liquidity and trading interest from diverse market participants. If a stock fails to meet these criteria, no new contracts will be issued on that stock.
Risk Mitigation
The proposed changes aim to mitigate risks associated with derivatives trading, such as market manipulation and increased volatility. By ensuring that only high-quality stocks in terms of size, liquidity, and market depth are included in the derivatives segment, SEBI seeks to protect investors and maintain market integrity.
Conclusion
SEBI’s proposed updates to the stock derivatives trading framework reflect the evolving market and the need for streamlined investor protection measures. SEBI has invited public comments on the proposed changes until June 19, 2024 from various stakeholders and interested parties to provide their feedback.
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