SEBI’s February 24, 2025, Consultation Paper: What Every F&O Trader Must Know

Key Highlights from SEBI's Latest Consultation Paper: Enhancing Trading Convenience and Strengthening Risk Monitoring in Equity Derivatives

To minimize the number of stocks entering the Futures & Options (F&O) ban period, the Securities and Exchange Board of India (SEBI) has introduced a fresh consultation paper. This initiative is aimed at curbing market volatility linked to derivative trading. The paper, Enhancing Trading Convenience and Strengthening Risk Monitoring in Equity Derivatives, presents key proposals to improve trading practices and bolster risk management. SEBI has invited feedback on these recommendations, with a submission deadline set for March 17, 2025.

Transitioning to a More Accurate Open Interest System

The core objective of SEBI’s consultation paper is to refine the methodology for computing Open Interest (OI) in equity derivatives. The proposed shift to a "Future Equivalent" (FutEq) or Delta-based approach is expected to offer a clearer insight into market exposure while preventing traders from bypassing position limits in index derivatives. This transition aligns with SEBI’s broader goal of strengthening risk monitoring mechanisms and enhancing trading efficiency.

Currently, OI computation follows a notional approach, which often fails to aggregate data across futures and options accurately. This discrepancy results in an imprecise reflection of market risk. SEBI aims to rectify this issue by integrating Delta-based OI calculations, allowing for a more comprehensive exposure measurement. Since FutEq OI for options is subject to rapid fluctuations based on market conditions, SEBI’s revised approach incorporates multiple "Greeks" to ensure precise risk assessment.

Key Proposed Changes in the F&O Segment

Delta-Based Open Interest Calculation

SEBI suggests replacing the existing notional-based OI calculation with a Delta-based system. Under the current system, every trade in the F&O segment contributes to the OI calculation, with the notional value of options included in determining the Market Wide Position Limit (MWPL). This often results in the MWPL crossing the 95 per cent threshold sooner, leading to stocks entering the F&O ban.

The proposed Delta-based method addresses this issue by factoring in the Delta of the strike price rather than its notional value. SEBI also recommends modifying the index derivative position limits and recalculating MWPL to ensure a more accurate representation of market risk.

Revised Market Wide Position Limits (MWPL)

The new framework will redefine MWPL by using the lower value between 15 per cent of free-float market capitalization or 60 times the Average Daily Delivery Value (ADDV) in the cash market. Additionally, MWPL will be adjusted quarterly, based on the rolling ADDV of the preceding three months.

Intraday Monitoring of MWPL Utilization

Acknowledging the volatility of FutEq OI during trading hours, SEBI proposes that MWPL utilization be tracked at least four times per session. Real-time intraday snapshots will be available for traders to enhance risk management.

Position Limits for Single Stocks During Ban Periods

To prevent stocks from frequently entering the F&O ban, SEBI suggests that any new trades in a stock already under restriction must reduce the trader’s initial FutEq OI for the day. Trading software used by brokers will be updated to enforce these restrictions effectively.

Revised Index Options Limits

SEBI is considering revised limits for index options, ensuring both end-of-day and intraday exposures are accounted for in market risk calculations.

New Exposure Limits for Mutual Funds and AIFs

Mutual funds and Alternative Investment Funds (AIFs) will now have their exposure measured on a Delta basis, with net exposure determined by calculating the difference between long and short Delta positions across instruments.

Extension of Pre-Open and Post-Closing Sessions

SEBI proposes extending the pre-open and post-closing trading sessions to include current-month futures for both individual stocks and indices. This extension will also apply to futures contracts in the last five days before expiry next month.

New Eligibility Criteria for Derivatives on Non-Benchmark Indices

SEBI is introducing additional eligibility criteria for derivatives linked to non-benchmark indices to ensure sufficient diversification.

Entity-Level Position Limits for Single Stocks

SEBI plans to impose entity-level position limits based on a percentage of MWPL and total FutEq OI across exchanges. These limits will vary based on the participant category, including stock brokers, foreign portfolio investors (FPIs), and retail traders.

Conclusion

SEBI’s latest consultation paper represents a pivotal move toward improving market stability and trading efficiency in the F&O segment. By transitioning to a Delta-based OI system, revising MWPL calculations, and introducing real-time risk monitoring, SEBI aims to establish a more transparent and resilient trading framework. Market participants are encouraged to provide their feedback before the March 17, 2025 deadline.

Disclaimer: This article is for informational purposes only and should not be construed as investment advice.