Phased physical settlement of stock derivatives mandatory, says Sebi

Markets regulator Sebi on Wednesday decided to make physical settlement of stock derivatives mandatory in a phased or calibrated manner, a move that could bring some much-needed balance between equity cash and derivative segments.

The regulator has strengthened the existing entry criteria for introduction of stocks into the derivative segment in line with the increase in market capitalisation since the last revision of the criteria in 2012, Sebi said in circular.

Accordingly, existing criteria like market wide position limit and median quarter-sigma order size has been revised upward from current level of Rs 300 crore and Rs 10 lakh, respectively to Rs 500 crore and Rs 25 lakh, respectively.

An additional criterion of average daily deliverable' value in the cash market of Rs 10 crore has also been prescribed. The enhanced criteria need to be met for a continuous period of six months.

"It has been decided that physical settlement of stock derivatives shall be made mandatory in a phased/calibrated manner," Sebi noted.

To begin with, Sebi said that stocks which are currently in derivatives but fail to meet any of the enhanced criteria, would be physically settled.

However, such stocks would exit the derivative segment if they fail to meet any of the enhanced criteria within one year or fail to meet any of the current existing criteria for a continuous period of three months.

Stocks which are currently in derivatives and meet the enhanced criteria would be cash settled. Such stocks if they fail to meet any one of the enhanced criteria for continuous three months will move from cash settlement to physical settlement.

After moving to physical settlement if such stock does not meet any of the current existing criteria for a continuous period of three months, then it would exit out of derivatives.

After a period of one year only those stocks which meet the enhanced criteria would remain in derivatives.

Derivatives in financial markets typically refers to a forward, future, option or any other hybrid contract of pre- determined fixed duration, linked for the purpose of contract fulfilment to the value of a specified real or financial asset or to an index of securities.

Broadly, there are two types of derivative contracts -- futures and options. A futures contract means a legally binding agreement to buy or sell the underlying security on a future date, while options contract gives the buyer or holder of the contract the right (but not the obligation) to buy or sell the underlying asset at a predetermined price within or at end of a specified period.

This circular would come into force with immediate effect, the Securities and Exchange Board of India (Sebi) noted.

Besides, the exchanges have been asked asked to put in place proper systems and procedures for smooth implementation of physical settlement and take necessary action to give effect to this circular.

"No new contract shall be issued on stocks that may exit the derivatives segment, however, the existing unexpired contracts may be permitted to trade till expiry and new strikes may also be introduced in the existing contract months," it added.

Earlier in September, Sebi had issued a consultation paper asking market participants to submit their views on whether physical settlement should be done in a phased manner starting with stock options followed by stock futures.