Kindly help me in understanding about the new rules regarding physical settlement in Certain Futures and option segement stocks introduced by sebi.
What is this norm about?
Are we not allowed to that overnight positions in these stock derivatives unless we have them in the same quantity in cash market?
as far as i understood with the help of this community friends,
if you don’t square off your position till expiry in specific stocks derivatives, after expiry you’ll be credit same no of shares of such company to sell in equity.
it’d be regular if you square off your position before expiry minute.
Can check this circular, it says only if one let it expire on expiry day. Options are settled in European style for physical delivery, means which can be exercised only on expiry day. More details on settlement are awaited from exchange.
It would be nice if they had mentioned any reasons for converting FNO to delivery from the current cash settlement. Is it just only for these FNO scrips mentioned, or would it be extended to the others as well in future? Maybe, anyone who knows about it, kindly share the reasons.
My personal view on this.
*Data and material is collected from various sources.
Before commenting on actions of SEBI I believe first we should know the reasons that prompted SEBI to consider these kind of formidable changes to F&O market.
According to finance ministry data, equity derivative markets are growing disproportionately compared to equity cash market, in 2017 F&O turnover was 18 times that of cash market turnover compared to 9 times in 2011 and 3 times in 2009.Alarmingly this growth is witnessed with decrease in number of derivative investors to 5.7 lakhs in 2017 compared to 10.6 lakh investors in 2010.
India ranks second in the world only next to Korea in terms of ratio of derivative turnover to cash turnover. Also according to global standards percentage of non-institutional trades in derivatives accounts for more than 58% which is considered as quite high. Individual investors contribute to almost 1/4th to the total volume of equity derivative trades in India and some percentage of this never traded in cash market. Retail investors in India bet on a notional value of $800 billion of stock futures in 2016, more than the value of stock futures traded in all of Europe, Hong Kong and Singapore combined.
Definitely this data suggests growth in derivative markets in India is mainly driven by speculation and is not sustainable.Also after analyzing this data finance ministry has a reason to concern and wants
SEBI to contain this alarming growth of derivatives compared to equities and want to implement measures that boosts growth of cash markets.
In order to attain sustainable growth,to rationalise, reduce speculation by retailers and to increase their participation as a whole in F&O SEBI is mulling various options.
Considering to increase minimum contract size to 10 lakhs from current 5 lakhs, but this is mostly ruled out as there was no effect intially when contract size was increased to 5 lakhs from 2 lakhs and currently there are handful of stocks whose contract size is already much above than 10 lakhs. Also this implementation can lead to rise of dabba trading again in India where one can bet without paying any taxes in multiple small lots.
Recently SEBI notified the revised framework for stock derivatives trading under which the stocks that fails to meet the enhanced eligibility criteria will be moved from cash settlement to physical settlement. The move is part of Sebi’s broader plan to completely move towards the physical settlement of stock derivative contracts, which according to it is necessary to curb high amount of speculation in the markets. No doubt, this move will filter out companies with lower trading interest from the F&O segment but few believe in first place stringent criteria should be there for any stock to be allowed to trade in F&O.It is also necessary for the regulators to strengthen the support systems before announcing such measures. Physical settlement is mandatory in several global markets. However, all these markets have strong stock lending and borrowing (SLB) mechanism through which investors borrow stocks at a marginal cost. However, SLB in India is still evolving, leaving little choice for derivatives investors who take short positions.
Another proposal from SEBI is to alienate retail investors from F&O is restriction on trade in cash and derivatives based on their disclosed income according to their income tax return over a period of time. For exposure beyond the computed exposure, the intermediary would be required to undertake rigorous due diligence and take appropriate documentation from the investor,which is highly impractical for brokers to implement this. Also client can give same ITR to multiple brokers and trade with additional exposure than permissible limit, one wonder how this can be kept under check? What if one inherited capital and want to trade with that? so, there are many questions unanswered with this proposal.
Also SEBI is considering to introduce concept of product suitability for investors in India as prevalent in other advanced markets. The main motive of this would be “Any product sold to investor should be suitable to him”. Not sure how this will evolve considering various parties involvement,customized needs, individual risk preferences, eligibility and different financial capabilities.
Few experts also suggest so as to curb speculation by retailers regulators should address lower taxes on options.As Securities Transaction Tax (STT) on options trades is levied on the premium amount only while it is levied on the full value in cash market trades.
Few suggest that SEBI should consider relevant education as prior eligibility for investors to trade in F&O, in this way they are fully aware of risks involved upfront.
The other focus of SEBI was on algorithmic trading framework and the regulator decided to streamline the segment, it allowed for members to operate from the co-location facility (as this would reduce costs),provided for dissemination of tick-by-tick data to all trading members; tightened the criteria under the order-to-trade-ratio which will now apply a penalty for orders at plus/minus 0.75% of the last traded prices, against plus/minus 1% earlier and extended its applicability to the cash segment; called for a unique identifier for each algorithm; enhanced disclosures on latency by exchanges.
The regulator also made norms more stringent for errant listed companies and allowed stock exchanges to impose fines for non-compliance with the new rules. It also empowered the stock exchanges to freeze shareholdings of promoters in non-compliant entities (as well as their holding in other securities) and to suspend their listing.
Considering the motives of SEBI one should appreciate it but too many regulations within short period of time may play spoilsport, kill liquidity and shatter derivative markets resulting in rise of parallel markets such as dabba trading.
Thanks for your time, and for a detailed note, pretty detailed at that!
Would have been better if SEBI had given such details themselves!
@siva @Abid_Hassan @nithin see if sebi is sooo concerned about the derievatives market overtaking the cash market, why not just introduce american styled options than physical settlement. Correct me if i’m wrong on this one, if sebi introduces physical settlement then it does’nt mean that the speculation is gonna drop drastically, people are just gonna rollver to the next month naturally because of gamma risk and other factors. With american style options there is always a chance, for example if an option seller turns of to be wrong then he could end up long stock which would create volume in the cash market. The indexes i understand should be cash settled but for stocks there is no need to have european style options just because they have lower premiums. Higher premiums might not only discourage really really small sized retailers who are not pros to loose their “POCKET MONEY”. Moreover it will help more sophisticated retailers who ‘sell’ options to bucket higher premium. This is my point of view. Feel free to reply your pov 
After going through your posts again , i have noticed that , derivative settlement system in to physical and also if Option exercise style changed to American style will hurt the most, to the option sellers so i think , SEBI’s intention of hurting retail trader’s , will backfire 
I believe this move of SEBI is just a starting point, broader plan is that only,to introduce American style for stock options and to bring all stocks under F&O to physical settlement mode.
You may be right but theoretically this move should enhance SLB mechanism in India thus giving some additional benefits for investors who hold stocks. This in-turn should motivate people to invest in cash markets, at-least in F&O scrips.
Also if possible go through the criteria for any stock to continue under F&O in this new revised framework, An additional criterion, of average daily ‘deliverable’ value in the cash market of ₹10 crore, has also been added now. With these new criteria, stocks with no trading interest or a mere speculative nature should be moved out of F&O.
Said that no one can exactly predict how this move will progress, just hope for the best and needless to say that time will answer everything.
The restrictions on the participants, be they retail or institutional, seem discriminatory and dumb. Also restricting the participating products is against providing accessible hedging.
So SEBI is damaging existing things and not improving them. Restricting speculation also makes hedging difficult; the main reason FnO exists for.
What if SEBI simply mandate one side (selling) of FnO transaction to hold (not borrowed) the actual underlying instead of margin money? (Let us keep index FnO aside for now).
There is a lot of things the SEBI can do.
There could be a lot more!
Already client would have paid upfront Span + Exposure.
Along with this Span + Exposure extra 50% of the contract value
OR
Including upfront Span + Exposure its total 50% of the contract value.
@siva @MohammedFaisal @nithin Pls explain once again
Two times the SPAN + Exposure margin.
Eg. If SPAN + Exposure margin is 200,000, on Wednesday and Thursday of expiry week it will increase to twice of 200,000 ie. 400,000.
Yes, it is the same for Option selling.
Thank you so much.
What about Option Buying Margin policy for Physical settlement?