Capital markets regulator SEBI has announced a slew of measures to strengthen equity index derivatives framework following its consultation paper on July 30, 2024. SEBI says these measures will ensure investor protection and market stability. Via its latest circular, the regulator has called for an upfront collection of "option premium" from options buyers, removal of calendar spread treatment on the expiry day, intraday monitoring of position limits, contract size for index derivatives, and rationalisation of weekly index derivatives products, and increase in tail risk coverage on the day of options expiry.

Options to be paid upfront

SEBI has now decided to mandate the collection of options premium upfront from option buyers by the trading member (TM) or clearing member (CM). This has been done, says SEBI, to avoid any undue intraday leverage to the end-client, and to discourage any practice of allowing any positions beyond the collateral at the end-client level. Options prices move in a non-linear way and carry very high implicit leverage. These are timed contracts with the possibility of fast-paced price appreciation or depreciation.

Explaining what this means, Deepak Shenoy, founder and CEO, CapitalMind says on X that option premiums have to be paid by options buyers. "Sounds obvious, but currently, intraday, the exchanges just block the broker's collateral for options bought, which therefore allows one person to effectively buy and sell intraday using another person's collateral." He says this must be for a few brokers that provided this facility to allow "mad" intraday options buy positions. "From Feb 2025, this won't happen - clients will have to pay up from their money for such purchases."

No calendar spread on expiry day

The regulator says the benefit of offsetting positions across different expiries ('calendar spread') will not be available on the day of expiry for contracts expiring on that day. Expiry day can see significant basis risk, where the value of a contract expiring on the day can move very differently from the value of similar contracts expiring in future. The relatively large volumes are witnessed on the expiry day vis-à-vis future expiry days, and it also represents an enhanced basis risk.

SEBI says it would also align "calendar spread treatment" with a cross-margin framework on correlated indices having different expiries, wherein such cross-margin benefit is fully revoked at the start of the first of the expiring correlated indices.

"This is not a bad idea, as there was a large amount of retail scalping happening on daily options expiries, especially selling straddles. There is systemic risk in case the offsetting calendar option doesn't move anywhere close to the expiring one (can happen in case of sudden spikes) - which makes sense on expiry day because max trading happens there," says Shenoy.

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