SEBI proposes tighter rules for derivatives trading on individual stocks to avert risk of market manipulation

The Securities and Exchange Board of India (SEBI), which serves as the country's markets regulator, has suggested stricter regulations for trading individual stock derivatives. SEBI believes these new rules are essential to prevent the risks of market manipulation, especially after the significant surge in options trading recently.

This decision follows information from two sources who informed Reuters in April that India's leading financial regulators plan to establish a committee. This committee will evaluate the stability risks arising from the rapid growth in the derivatives markets.

Over the past five years, options trading in India has seen a significant increase, driven primarily by retail investors. According to the NSE, the notional value of index options traded more than doubled in 2023-24, reaching $907.09 trillion compared to the previous year.

A discussion paper released on Sunday on the Securities and Exchange Board of India's (SEBI) website suggests that derivatives contracts on individual stocks should possess adequate liquidity and trading interest from market participants. This requirement, which currently applies only to contracts on indexes, is being proposed for individual stocks as well. The publication of a discussion paper is the initial step taken by Indian regulators to modify policies or rules.

“Without sufficient depth in the underlying cash market and appropriate position limits around leveraged derivatives, there can be higher risks of market manipulation, increased volatility, and compromised investor protection,” SEBI said.

According to the proposed rules, a stock must have been traded for 75% of the trading days to be eligible for futures and options (F&O) trading, SEBI stated, although the specific time period for this requirement was not mentioned.

Additionally, SEBI proposed that 15% of active derivatives traders should have traded the stock. The stock should have an average premium daily turnover of 1.5 billion rupees ($18 million), and the average daily turnover should range between 5 and 15 billion rupees. Furthermore, the maximum number of open F&O contracts allowed for the underlying stock must be between 12.5 and 17.5 billion rupees. SEBI did not specify any time periods for these requirements.

The regulatory scrutiny follows efforts by India's leading stock exchanges to attract investors with new products and lower fees. These competitive strategies have intensified the battle for a share of the rapidly growing derivatives market, subsequently driving a surge in trading activity.

According to data from the Futures Industry Association, out of the 108 billion options contracts traded globally in 2023, 78% were executed on Indian exchanges. Retail investors account for 35% of derivative trading in India.

In a research note, financial services firm IIFL stated that up to 25 of the 182 stocks currently eligible for futures and options contracts might become ineligible if the regulator's proposals are implemented.