Background:
Derivative markets enhance price discovery and market liquidity. However, 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.
To help develop the securities market while being mindful of these concerns, SEBI last established a framework in 2018 for the selection of stocks eligible for derivatives trading. Given the evolving market context since then, SEBI is now proposing to update this framework and its criteria accordingly.
Need for review:
As the broad market parameters have shown significant growth. In turn, the criteria for entry and exit of stocks in the derivatives market should keep pace with the evolving market.
In addition, stocks that have low derivative turnover, low open interest, and narrower participation in the derivatives segment are vulnerable to manipulation and expose investors to heightened risk. The market has seen a wide range in average turnover and open interest across different stocks. The same has been illustrated below.
It may be observed from the above that stocks A and B have substantially lower Average Daily Open Interest and/ or Average Daily Traded Value than stocks C and D. There is a need to weed out stocks with consistently low derivative turnover and open interest.
SEBI is proposing to Introduce Product Success Framework (PSF) for stock derivatives
As discussed above, once a stock is introduced in derivatives segment, to ensure orderly trading and market integrity, derivatives contracts on such stock should have sufficient liquidity and should elicit sufficient trading interest from diverse market participants.
Currently, the product success framework is only applicable to index derivatives. The said framework mandates that derivatives on an index should have sufficient turnover, open interest, and widespread participation. If any index fails to satisfy any of these criteria, then no fresh contracts shall be issued on that index.
Product Success Framework for Index Derivatives
15% of trading members active in all index derivatives or 20 trading members whichever is lower should have traded in any derivative contract on the index being reviewed in each of the months during the review period.
Trading on a minimum of 75% of the trading days during the review period.
Average daily turnover of at least INR 10 crore during the review period, and
Average daily open interest of INR 4 crore during the review period.
On similar lines, it is proposed to introduce additional exit criteria for single stock derivatives, based on performance of derivative contracts.
In view of the changing market dynamics, the criteria for entry of stocks are proposed to be revised appropriately as under:
| Criteria | Existing criteria | Tentative threshold/ range | Rationale for change |
|---|---|---|---|
| Average Daily Market Capitalization and Average Daily Traded value (ADTV) in the previous six months on a rolling basis | Amongst top 500 stocks | Amongst top 500 stocks | No change |
| The stock’s Median Quarter Sigma Order Size (MQSOS) over the last six months, on a rolling basis, shall not be less than: | Rs. 25 lakhs | Criterion proposed to be a figure between Rs. 75 and 100 Lakhs | Since average market turnover is now over 3.5 times the figure during the last review, MQSOS criteria would need to increase between 3-4 times. |
| The stock’s market wide position limit (MWPL) on a rolling basis shall not be less than | Rs. 500 crs. | Criterion proposed to be between INR 1,250 crs. to INR 1,750 crs. | Market capitalisation now is now 2.8 times the last review, while turnover is over 3.5 times |
| The stock’s Average daily delivery value (ADDV) in the cash market, in the previous six months on a rolling basis, shall not be less than | Rs. 10 crs. | Criterion proposed to be a figure between INR 30 crs. – INR 40 crs. | Average Daily Delivery Value has increased by over 3 times since the last review. Note that upon expiry, unlike index derivatives that are cash settled, single stock derivative are physically settled. |
| The stocks to meet the criteria laid down for the Product Success Framework (PSF) for Index derivatives | PSF criteria is applicable for index derivatives | The criteria proposed to be as under: | This is required to ensure that stocks have sufficient turnover, open interest and widespread participation. |
| — | — | A) At least 15% of trading members active in all stock derivatives or 200 members, whichever is lower, shall have traded in any derivative contract on the stock. | — |
| B) Trading on minimum 75% of trading days. | |||
| C) Average daily turnover (premium basis) would be minimum Rs 150 crores | |||
| and | |||
| D) Average daily OI would be a minimum between Rs.500 crore to 1500 crores |
You can read the full SEBI Consultation paper here:
and will continue to do so in the future.