Sebi may cut non-expiry day margins to boost longer-term derivatives trading
This move could deepen the derivatives markets, where most of the trading by large, high-frequency and proprietary traders as well as individual investors takes place on weekly option contracts' expiry.
India’s capital markets regulator is likely to reduce margins on equity derivatives on non-expiry days to encourage big traders to place longer-term bets rather than focus solely on the expiration day, said two people aware of the development.
A margin is the amount that an investor must pay upfront to initiate a trade in the derivatives segment. The Securities and Exchange Board of India’s (Sebi’s) move to cut these margins could deepen the derivatives markets, where most of the trading by large, high-frequency and proprietary traders as well as individual investors takes place on the expiry day of weekly option contracts.
"The RMRC (Sebi’s risk management and review committee) is discussing a rationalisation of margins as the current ones can discourage long-term traders, especially on non-expiry days," said one of the persons cited above.
The second person said Sebi would seek feedback from market participants on these changes.
Queries emailed by Mint to Sebi did not elicit a response.
How India differs
Indian exchanges require clients to post both SPAN (standard portfolio analysis of risk) margin and extreme-loss margin (ELM) through their brokers to take derivative positions, rather than just the SPAN margin, which is the standard practice globally.
SPAN is a proprietary methodology of the Chicago Mercantile Exchange to assess the risk to a trader's portfolio from events that could increase volatility. It is considered adequate to cover 99.975% of likely risk scenarios that could affect a trader's portfolio.
However, in addition to SPAN, Indian bourses' clearing corporations impose an ELM that is based on the derivative's notional or total value as an added guardrail. This ELM significantly increases the margin an investor must put up to buy or sell a contract.
What's the plan?
According to the second person cited above, Sebi could consider reducing the ELM from 2% to 0.5-1% on non-expiry days only for a hedged portfolio, with an unhedged portfolio attracting the normal 2% ELM. On expiry day, the ELM would be retained at SPAN plus 4%, the second person said.
For instance, if the SPAN on a Nifty hedged options position at 26,000 index value is ₹10,000 and the ELM is 2% of the notional value of the contract, the total margin would work out to ₹49,000 – 2% of the Nifty contract value of ₹19.5 lakh (26,000x75 shares per contract) plus the SPAN margin. If the ELM were halved to 1% of the notional value, the total margin would drop substantially to 29,500, this person said.
A hedged position is one that is covered by an opposite trade on the same security in a different segment, say cash versus futures or futures versus options. An unhedged position is a plain-vanilla long or short position .
Kruti Shah, a quant analyst at Equirus Securities Pvt Ltd, said, "When I have a hedged position, which mitigates my risk, why should I be charged an exposure or ELM over and above SPAN, which itself is adequate to cover almost all the risk to my portfolio?"
Bias for expiry-day trading
The Nifty options premium turnover of ₹77,379 crore on expiry day for the week ended 12 December was almost 50% more than the average daily turnover of ₹52,561 crore during the week. Similarly, for Sensex, options turnover on expiry day at ₹53,834 crore was 125% of the average daily turnover for the week ended 12 December, reflecting a preference for expiry-day trading.
A broker Mint spoke to said his firm had informally requested Sebi to review margins in the cash segment of exchanges such as BSE and NSE as well. On such trades, the exchange collects a 20% margin upfront if a client buys or sells a stock intraday.
Sebi increased the margin on the cash segment trading for clients from nearly zero to 20% in phases between 1 December 2020 and 1 September 2021 to mitigate systemic risk from brokers giving certain clients 40 to 50 times leverage. That prompted many traders to move away from intraday trading on the cash segment to weekly trading on index options.
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