F&O entry, exit revamped: How Sebi has raised bar for stock options trading

The recent surge in F&O activity, particularly focused on individual stocks, has triggered SEBI's intervention

India's stock market regulator, Sebi, is cracking down on overly speculative trading in individual stocks. Here's a breakdown of the new rules and what they mean for investors:

What's the problem?

Sebi is concerned about a recent surge in speculative bets on individual stocks through "Futures & Options" (F&O) contracts. These contracts allow investors to bet on future stock prices without actually buying or selling the shares. The regulator worries that this speculative activity isn't reflecting the true value of companies and could pose risks to investors. They've observed trends like last-minute buying sprees on expiring contracts, suggesting short-term bets rather than long-term investment strategies.

 

What is happening?
 

1. Stricter rules for including stocks in Options Trading (F&O):

Sebi is raising the bar for stocks to be included in the F&O segment. They need to be among the top 500 companies in terms of market capitalization and daily trading activity. Additionally, they must demonstrate sufficient liquidity by meeting higher minimum daily trading volumes and order sizes. This ensures that only well-established and actively traded stocks are available for F&O contracts, potentially reducing the allure of speculative bets on less-liquid companies.

Large Market-Wide Position Limit: The total amount of money that can be bet on a particular stock through F&O contracts needs to be substantial (Rs 1,500 crore). This discourages manipulation by limiting the potential impact of smaller players.

Higher Median Quarter-Sigma Order Size: This is a technical measure of order size variability. SEBI is raising the minimum acceptable level (Rs 75 lakh) to ensure there's enough trading activity in the underlying stock.

Increased Minimum Daily Delivery Value: This refers to the actual buying and selling of shares (delivery) happening in the cash market. Sebi is raising the minimum daily average delivery value (Rs 35 crore) to ensure the stock has real-world demand, not just speculation in the F&O segment.

In simpler terms, only well-established and actively traded companies will be eligible, making it harder for smaller or less liquid companies to be used for speculative bets through options contracts. This aims to create a more stable and reliable F&O segment that reflects the actual market activity.

2. Removing less active stocks from options trading:

Sebi is creating a process to remove stocks from the F&O segment if they become inactive. Stocks with persistently low liquidity or minimal trading activity in the cash market will be removed. This ensures that the F&O segment reflects the actual market activity instead of harboring dormant or less-traded stocks. The emphasis is on having a dynamic F&O segment that reflects the current market landscape.

Here's what triggers a stock's exit:

Active Trader Participation: At least 15% of active traders (or a minimum of 200 members, whichever is lower) need to have participated in trading the stock being reviewed. This ensures there's enough investor interest in the underlying stock.

Daily Turnover: The average daily trading value of the stock (turnover) needs to be at least Rs 75 crore. This indicates a healthy level of buying and selling activity in the cash market.

Open Interest: The average daily "notional open interest" (the combined value of outstanding futures and options contracts) needs to be at least Rs 500 crore. This reflects the amount of money being bet on the stock through F&O contracts.

These criteria only apply after a grace period. Stocks need to be in the F&O segment for at least 6 months before these exit rules can be triggered. This gives them time to establish themselves and attract enough trading activity.

Overall, Sebi is trying to keep the F&O segment dynamic. Only actively traded stocks with sufficient investor interest will remain in the F&O segment. This aims to prevent inactive stocks from creating a cluttered and potentially misleading F&O market.

3. Expert group to review options trading:

Sebi has formed a group of experts to study the options market further.

This group will look at ways to improve investor protection and manage risk.

They'll also explore how to develop the options market in a healthy way.

What does this mean for investors?

Less Speculation: The new rules aim to reduce purely speculative trading in individual stocks using F&O contracts. This could make the market more focused on long-term investment strategies.

More Liquidity: By removing less-traded stocks from F&O, SEBI hopes to improve overall liquidity in the segment. This could benefit investors by making it easier to enter and exit F&O contracts.

Some existing stocks in the F&O segment might be removed if they don't meet the new criteria. However, the overall impact is expected to be limited.

Sebi has also introduced a more streamlined process for companies seeking to delist from stock exchanges. Previously, companies relied on a book-building process where public shareholders are invited to tender their shares at a specific price. Now, companies can offer a fixed price to buy back shares, potentially making the delisting process more efficient and cost-effective. This change reflects SEBI's recognition that some companies may have legitimate reasons for going private, and it streamlines the process for them.

The move would weed out stocks with consistently low turnover from the Futures & Option (F&O) segment of the bourses.

The review was done considering remarkable growth in market parameters, reflecting the size and liquidity of the cash market like market capitalisation and turnover. The last review of the eligibility criteria for the introduction of stocks in the derivatives segment was conducted in 2018.