The Securities and Exchange Board of India has proposed a change in the methodology for calculating outstanding positions in stock futures and options. This move is expected to reduce the possibilities of manipulation in derivatives trading. The plan includes introducing tighter rules, such as regular monitoring of positions during trading sessions, amid growing concerns that influential firms may be manipulating trades in the country’s growing futures and options markets.

In a consultation paper released on Monday, the capital markets regulator proposed changes in the calculation of Open Interest (OI) and market-wide position limit (MWPL) in stock derivatives.

“The regulator may have seen instances where positions are created in advance based on some corporate news, to cross the market-wide limit, and push the security into ban until positions are squared off, so no new positions can be created,” said Rajesh Palviya, head of technical and derivatives research at Axis Securities. “The new mechanism will make this more difficult for the participants to do so.”

When the outstanding positions in stock derivatives reach the maximum permitted threshold of 95% of the market-wide limit, the contract enters the ban period. Once a stock contract enters the ban period, trading is only allowed to cut positions till the market-wide limit touches 80%.

A broker, who did not wish to be named, said that the regulator has modified the calculation of Open Interest (OI) in stock options by assigning weights based on how far the contracts are from the existing levels.

Proposals Likely to Curb Manipulation

Under the proposed Delta-based or Future Equivalent approach, options contracts farther from the at-the-money strikes (current levels) will get less weightage assigned to their value in the open interest (OI), as against uniform calculation for all options strikes currently, said Chandan Taparia, head of technical and derivatives research at Motilal Oswal Financial Services.
“This will result in the open interest of stocks and indices options getting adjusted fairly,” he said.

The broker said the proposal would make it more difficult for select market participants to push the market-wide limit of stock derivatives to the 95% threshold.

The Sebi consultation paper said that between July 1, 2024, and September 30, 2024, there were 366 instances of stocks entering the ban period. The proposed rule would have reduced such instances to 27.

Sebi also proposed to decrease the market-wide position limit of a stock contract from 20% of the underlying stock’s free-float market capitalization to 15% of the stock’s free-float market capitalisation or 60 times the average daily delivery value (ADDV) of the underlying shares, whichever is lower.

TIGHTER MONITORING

The regulator said clearing corporations of exchanges will also monitor whether the position limits are being adhered to at least four times in a trading session. Brokers said this is expected to curb the build-up of bets by bigger trading firms during the day, which could lower the volatility in the market induced by derivatives.
“Pre-open and post-close market sessions will allow the traders to have a better price and premium discovery, in sync with the cash market. And revision in eligibility criteria for no-benchmark indices may prompt other sectoral indices to also enter the derivatives segment,” said Palviya.

It also recommended the introduction of pre-open and post-closing sessions for derivatives, while revising entity-level position limits (brokers, FPIs, and mutual funds) for single stocks and establishing eligibility criteria for derivatives on non-benchmark indices such as sector or theme benchmarks.