SEBI Proposes New Measures to Limit Equity Derivatives Volatility Spillover

Regulator Seeks Public Feedback Before March 17 on Proposed Reforms

Mumbai, February 25 – The Securities and Exchange Board of India (SEBI) has proposed a set of regulatory changes aimed at curbing potential market manipulation and minimizing the spillover of equity derivatives volatility into the broader cash market. This move comes after the Indian stock market witnessed sharp corrections following record highs in September 2024.

Proposals by SEBI

1. Revised Position Limits for Single-Stock Derivatives

   • SEBI plans to modify how open interest in a single-stock derivative is calculated to ensure a more accurate assessment of market exposure.
   • It proposes a new position limit of 15% of the free-float market capitalization of a stock or 60 times the average daily delivery value, whichever is lower.
   • Currently, the cap is set at 20% of free-float market capitalization or 30 times the daily average.
   • This change aims to reduce artificial price movements and manipulation by preventing stocks from being pushed into the ban period, where only squaring off of existing positions is allowed.

2. Restrictions on Non-Benchmark Index Derivatives

   • SEBI intends to impose stricter eligibility criteria for index derivatives other than the BSE Sensex and NSE Nifty 50 to prevent excessive speculation.
   • Derivatives will only be permitted for indices that meet the following conditions:
     • A minimum of 14 constituent stocks.
     • The combined weightage of the top three stocks must be below 45%.
     • The weight of the largest constituent must not exceed 20%.
   • This move is expected to prevent market manipulation by curbing the ability of traders to take large unmonitored positions through an index with a concentrated stock base.

3. Impact on Nifty Bank and Other Popular Indices

   • The proposed changes could significantly impact the Nifty Bank Index, which is widely traded in India.
   • The Nifty Bank Index currently has 12 constituents, with its top three stocks accounting for over 60% of total weight (as of January 31, 2025).
   • Experts believe SEBI’s move will encourage the addition of more stocks in such indices, reducing the potential risk of manipulation.

4. Introduction of Pre-Open Session for Futures Market

   • To bring more stability to the derivatives market, SEBI has proposed implementing a pre-open session for futures trading, similar to what is already in place in the cash market.
   • This will apply to both single-stock and index futures, helping in better price discovery and reducing speculative spikes at market open.

Why SEBI Is Tightening Derivatives Trading Regulations?

The Indian derivatives market has seen high volatility in recent months, largely driven by speculative trades and leveraged positions. SEBI had previously introduced stricter norms in October 2024, making it more expensive to trade derivatives. However, fresh concerns over market manipulation have prompted additional regulatory intervention.

Market experts believe these new proposals will:

• Reduce market manipulation risks, particularly in less liquid stock derivatives.
• Enhance market stability by curbing excessive speculation in highly concentrated indices.
• Improve risk management by ensuring that derivative products align with their underlying cash markets.

According to Abhilash Pagaria, Head of Nuvama Alternative and Quantitative Research, SEBI’s proposed reforms will help limit excessive speculation:

“A reduction in the weight of the top three stocks and the addition of more constituents will reduce the risk of potential manipulation of the index on the basis of a few stocks.”

Next Steps: Public Consultation Until March 17

SEBI has invited public comments on the proposed regulatory changes, with stakeholders given time until March 17, 2025, to submit feedback. Once finalized, these rules could significantly reshape how derivatives trading operates in India, ensuring a more balanced and less volatile market environment.

A Step Towards a More Transparent and Stable Market

SEBI’s latest proposals aim to enhance market integrity, limit excessive speculative trading, and protect retail investors from the unintended consequences of derivatives volatility spilling into the broader equity markets. If implemented, these changes will further align India’s derivatives market with international best practices, fostering long-term investor confidence.