Introduction:

Time and again, the Securities and Exchange Board of India (SEBI) has proposed guidelines to protect investors’ interests and maintain transparency in capital markets. Recently, it has given suggestions regarding strict regulations for individual stock inclusion in derivatives trading. What are these and their importance? Read on to find out.

The Background

Note that Sebi’s decision to develop these regulations comes from two sources. These sources informed Reuters back in April that the country’s apex regulator plans to form a committee to evaluate the risks related to stability arising from the monumental growth of India’s derivatives markets. Note that over the last few years, there has been a significant rise in options trading, especially from retail investors.

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However, the lack of depth in the underlying cash market has increased volatility and higher risks of market manipulation. To address these concerns, Sebi has proposed stricter norms.

What are the Guidelines?

Under the proposed guidelines by Sebi, for an individual stock to be included in the derivative trading, the same should have been traded for 75% of trading days. That’s not all. Also, for the stock to be included:

• It must have been traded by at least 15% of the active traders
• The stock’s average daily turnover should hover between Rs 500 and 1500 crores
• The average premium daily turnover must be at least Rs 150 crores

The capital market regulator, in its guidelines, has also suggested fixing the maximum number of open contracts for the underlying stock. From the present Rs 500 crores, it has been raised to Rs 1250 crores and Rs 1750 crores.

Other Guidelines

Apart from fulfilling the criteria mentioned above, a stock must fulfil certain other conditions to be included in derivatives trading. These include:

• Having a median quarter sigma order size between Rs 75 and Rs 100 lakhs in the last six months. Currently, it is at Rs 25 lakhs
• The rolling average daily delivery value should be between Rs 30-40 crores, from the present Rs 10 crores

Consequences of Not Meeting These Criteria

If a stock doesn’t meet the criteria mentioned above for three consecutive months, it must exit the derivatives segment. Also, it can’t have new contracts issued.

How Will the Move Help Investors?

Here’s how the move will benefit investors:

• Enhance Investors’ Confidence

One of the key ways this move will benefit investors is by improving the quality and stability of the stocks available for derivatives trading. Sebi’s proposal to include a minimum number of trading days and average daily turnover ensures that only well-established and actively traded stocks are eligible. This selective approach reduces the risk associated with less liquid or more volatile stocks. Thus, it provides a safer trading environment, boosting your confidence.

• Reduce Speculative Risks and Volatility

Sebi’s proposal addresses the speculative nature of derivative trading by ensuring that only stocks with substantial market participation are included. By setting a higher bar for inclusion, the move helps curb excessive speculation on thinly traded stocks. Such stocks often lead to exaggerated price swings and market volatility. Lower volatility translates to more predictable and stable markets. Thus, it provides a safer trading environment, boosting your confidence.

• Improve Market Liquidity and Efficiency

The inclusion criteria proposed by the SEBI will likely result in a more liquid and efficient derivatives market. Stocks that meet the revised standards are expected to exhibit higher trading volumes, contributing to improved market liquidity.

A liquid market is essential for the smooth functioning of the derivatives segment because it ensures you can promptly undertake buy and sell orders. This increased efficiency reduces transaction costs and enhances the overall attractiveness of the derivatives market.

• Support Long-term Investment Strategies

Sebi’s proposed stricter norms for including individual stocks in the derivatives trading segment mark a significant step towards a healthier and more resilient market. This benefits you by providing a safer and more predictable market and contributes to your long-term investment strategies.

Wrapping it Up

Sebi’s move augurs well if you are interested in derivatives trading as it lowers the chances of market manipulation significantly. However, its real impact will have to be seen in the upcoming days.

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