SEBI’s proposed changes to derivatives trading could stabilize share prices

Market Overview

The Securities and Exchange Board of India has launched new proposals to tighten derivatives market regulations. These measures follow concerns that fluctuations in the futures and options segment are impacting the broader stock market. The stock market reached record highs in September 2024 and has experienced significant declines, prompting regulatory scrutiny.

Proposed Regulatory Changes

SEBI has suggested reducing position limits for equity stock derivatives and implementing stricter conditions for index derivatives. These steps are intended to limit excessive risk accumulation and improve market stability.

Changes to Single-Stock Derivatives

SEBI has proposed linking the market-wide position limit for single-stock derivatives to the cash markets. Under this proposal, the position limit would be determined as the lower of:

• 15% of the stock's free-float market capitalization, or
• 60 times the stock's average daily delivery value.

This adjustment is expected to align derivatives trading with the liquidity of the underlying cash market, potentially reducing opportunities for market manipulation.

Revised Criteria for Index Derivatives

The regulator has also proposed that derivatives on indices other than the BSE Sensex and NSE Nifty 50 should only be available if the index meets specific conditions. SEBI emphasized that index derivatives are closely linked to the cash market despite being cash-settled.

To prevent undue concentration of market weight in a few stocks, SEBI has suggested that:

• Index derivative contracts should only be introduced on indices with at least 14 constituents.
• The combined weight of the top three stocks in an index should be less than 45%.
• No single stock should have a weight exceeding 20% in the index.

These changes aim to minimize the risk of market manipulation and excessive volatility in the derivatives segment.

Introduction of Pre-Open Session for Futures Market

SEBI has also proposed introducing a pre-open session for the futures market, similar to the practice in cash markets. Initially, this mechanism would be applied to current-month futures contracts on individual stocks and indices.

Consultation Period and Industry Feedback

SEBI has invited market participants to provide feedback on these proposals. Stakeholders must submit their responses by March 17.

Conclusion

SEBI's proposed changes reflect a broader effort to enhance transparency and stability in the derivatives market. By tightening position limits, setting stricter conditions for index derivatives, and introducing pre-open sessions, SEBI aims to mitigate risks and align derivatives trading with cash market dynamics. These measures will contribute to a more balanced and resilient financial market structure.