India Tightens Rules for Stock Derivatives Trading to Curb Risks

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India’s securities regulator has put forth proposals for stricter regulations on individual stock derivatives trading, citing concerns about the risks of market manipulation amidst a surge in options trading activity, especially by retail investors.

The exponential growth in options trading in India over the past five years, primarily driven by retail participation, has raised alarms. The notional value of index options traded skyrocketed in the fiscal year 2023-24, doubling from the previous year to $907.09 trillion, as reported by the National Stock Exchange (NSE).

In a discussion paper released on Sunday, the Securities and Exchange Board of India (SEBI) emphasized the importance of ensuring sufficient liquidity and trading interest in derivatives contracts on individual stocks. Currently, such requirements are only mandated for contracts on indexes.

SEBI highlighted the risks associated with inadequate depth in the underlying cash market and the absence of appropriate position limits on leveraged derivatives, which could lead to market manipulation, increased volatility, and compromised investor protection.

The proposed rules outline stringent criteria for stocks to qualify for futures and options (F&O) trading. These include trading activity on at least 75% of trading days, a minimum threshold of active derivatives traders, specified average daily turnover, and limits on the maximum number of open F&O contracts for the underlying stock.

The regulatory scrutiny follows intense competition among India’s top stock exchanges to attract investors through new products and reduced fees, driving heightened trading activity in derivatives markets. Indian exchanges accounted for a significant portion of global options contracts traded in 2023, with retail investors contributing substantially to derivative trading.

According to financial services firm IIFL, the implementation of SEBI’s proposals could render several stocks ineligible for F&O trading, impacting around 25 of the 182 stocks currently available for such trading.

A discussion paper serves as the initial step by Indian regulators to solicit feedback and initiate changes in policies or rules, signaling a proactive approach to address emerging market dynamics and safeguard investor interests.