F&O trading: Why Sebi's 7 proposals remind experts of South Korean stock market (2024)

Sebi's fresh consultation papers on futures and options (F&O), which suggested seven proposals to tame retail speculation in derivatives, if implemented fully, are seen hitting market volumes by about 30-40 per cent and earnings of domestic stock exchanges by 15-30 per cent, as per initial estimates. The steps are also seen hurting discount brokers, which tasted strong success in the last couple of years.

While market participants welcome a few proposals, others warned market volumes may take severe hit if implemented all at once.

BK Sabharwal, Chair for Capital Market & Commodity Market Committee at PHDCCI said the government has already increased STT on futures and options in the Union Budget 2024, which should have a significant dampening effect on the derivatives trading from October 1. Yesterday's discussion paper by Sebi was perhaps prepared even before the Budget announcement and, therefore, does not account for the impact of such changes, Sabharwal said.

"If all the 7 proposals are implemented as suggested in parallel, this could result in erosion of volumes from derivatives in a significant manner. Korea implemented similar measures in the past. However, the market there never recovered despite many attempts by the regulators to revive business activity. Even after 10 years, the volumes are lower. It would be therefore important for Sebi to implement changes only in a phased manner," Sabharwal said.

This, he said, is to make sure the overall vibrancy of the market is not impacted by too many hard measures at one time.

The Korea Exchange (KRX) had in 2012 increased the contract size of KOSPI 200 index options from KRW 100,000 to KRW 500,000 with effect from March 9, 2012. Once the world's largest derivatives market, South Korea saw a sharp fall in daily average trading volume and turnover in next several years.

Feroze Azeez, Deputy CEO at Anand Rathi Wealth said reducing volumes in the F&O segment will bring down the realised daily volatility and also intra-day volatility in Nifty because there is an expiry practically on all days.

"This is crucial as the large weights common across most indices. For example, HDFC Bank is a common stock for many indices. With these changes, market participants can expect a more stable market, which is beneficial for retail investors," he said.

Azeez said the measures are expected to lower monthly option prices, especially for OTM options. This will lead to reduced implied volatility and a more balanced option pricing skew, making the market more accessible and less risky for investors.

"Furthermore, by concentrating trading volumes on fewer strike prices, liquidity at these levels is likely to be maintained or even improved, which will lower the impact cost for large traders. Overall, these changes are anticipated to promote a healthier trading environment and support sustainable growth in the derivatives market," he said.

"In the age of advanced algorithms and evolving AI technologies, institutions and large traders often have a significant edge over retail traders. While these measures might be seen as a tough adjustment, they are necessary for long-term stability and fairness in the market," he added.

Jidesh Kumar, Managing Partner at King Stubb & Kasiva, Advocates and Attorneys said implementing the measures could lead to reduced trading volumes, particularly in options, and potentially prompt a shift towards futures.

"Retail participation in F&O might decline due to higher costs and stricter regulations, making the market less attractive for smaller investors. While some proposals may seem harsh, they aim to promote long-term market stability and protect investors from excessive speculation. Measures such as collecting option premiums upfront and increasing expiry margins could deter speculative trading but are essential for risk management," Kumar said.

Kumar added that the revising of the contract sizes and rationalising of strike prices may encourage broader participation but limit flexibility in trading strategies.

These steps seek to balance short-term inconvenience with the need for a more stable and secure market environment, he said.

Amit Goel, Co-Founder & Chief Global Strategist, Pace 360 cited Sebi chief Madhabi Puri Buch saying the annual loss of Rs 50,000–Rs 60,000 crore of household savings due to derivatives trading is a macro concern.

"There is an overabundance of speculative trading occurring in F&O. NSE data shows that retail investors alone account for around 50 percent of the trading volumes in index derivatives, surpassing proprietorship traders, foreign investors, and domestic institutional investors. We believe that the measures proposed by Sebi are aimed at controlling the exuberance in the Indian equity derivatives market," Goel said.

"Moreover, with the realignment of exchange transaction charges, higher STT introduced in the Budget, and the proposed regulatory framework, it is expected that there could be a rationalization in equity derivatives volumes," he added.