Retail Option Trading Drops by 20% After SEBI Measures

India’s capital markets regulator, the Securities and Exchange Board of India (SEBI), has been actively working to curb high-risk derivatives trading among retail investors. Over the past year, a series of regulatory measures have been introduced to reduce excessive speculation in the futures and options (F&O) segment. The impact of these regulations is now becoming evident, with a significant decline in retail derivatives trading activity.

SEBI’s 6-Step Framework and Its Implementation

In late 2023, SEBI introduced a 6-step framework aimed at reducing the risks associated with derivatives trading. The measures included:

• Increasing contract sizes for options to ensure that only investors with sufficient capital participate.
• Limiting weekly expiries to one per exchange to reduce speculative trading.
• Stricter margin requirements to deter excessive leveraging.
• Higher position limits for institutional traders to prevent market manipulation.
• Alignment of derivatives with cash markets for better risk management.
• Enhanced investor awareness campaigns highlighting the risks of F&O trading.

These regulations were implemented following a study that found retail traders had collectively lost nearly ₹1.8 lakh crore in options trading over the previous 3 years.

Decline in Retail Trading Activity

Since the new rules came into effect in November 2023, trading volumes in the F&O segment have witnessed a sharp decline. According to a recent report:

• Retail premium traded in January-February 2024 has declined by 20% compared to the pre-regulation average (April-October 2023).
• Institutional premium turnover has dropped even further, showing a 25% decline.
• Options contract volumes have declined across both retail and institutional investors by approximately 80%.

These figures indicate that SEBI’s measures have been effective in reducing speculative trading.

Impact on Retail Investor Participation

The new regulations have disproportionately affected retail investors, particularly those trading with lower capital. The report highlights that:

• Participation in the lower-end segment (traders handling less than ₹10 lakh) has declined by 25%.
• The decline in participation at the higher-end segment (traders handling large volumes) is around 7%.

This disparity stems from the fact that 25% of traders account for 95% of options premium turnover, meaning the impact of regulations has been unevenly distributed.

Institutional Trading Under Pressure

Institutional traders have also experienced reduced trading volumes, largely due to:

• Higher expiry-day margins on short positions, which have been in place since November 2023.
• Proposed index position limits, which could further restrict institutional trading activity.

SEBI has also proposed that market-wide position limits for single-stock derivatives be linked to cash market volumes. This would cap the position limit at the lower of:

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

If implemented, this move aims to reduce potential market manipulation and align derivatives risk with underlying stock liquidity.

What Lies Ahead?

While the decline in trading volumes is evident, analysts suggest that any second-order effects of SEBI’s regulations will take 6-12 months to fully materialise. Some industry experts believe that another round of tightening in the near future is unlikely, given the substantial impact the current measures have already had on market dynamics.

As the derivatives market continues to adjust to these changes, it remains to be seen how traders—both retail and institutional—adapt to the evolving regulatory environment.

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. This does not constitute a personal recommendation/investment advice. It does not aim to influence any individual or entity to make investment decisions. Recipients should conduct their own research and assessments to form an independent opinion about investment decisions. 

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