Context:
The Securities and Exchange Board of India (SEBI) might reconsider its proposal on the basis of the gross limit for all clients trading in index options after receiving overwhelming market feedback against it.
Main Points of SEBI’s Proposal
- Gross Limit on Index Options
- Is proposed to combat any manipulation and formulate better risk exposure.
- Is a summation of both long and short option positions’ deltas, gross instead of net.
- Aim: To restrict large manipulative positions mainly in individual stocks and index derivatives.
- Delta Based Calculation of Open Interest (OI)
- SEBI also suggested changing the basis of calculation of open interest to delta.
- Delta measures how much an option’s price changes with a change in the underlying index/stock.
- In this connection, the change has received positive feedback from market operatives.
What Is Open Interest?
Open interest is the total number of outstanding derivative contracts for an asset such as options or futures that have not been settled. Open interest keeps track of every open position in a particular contract rather than tracking the total volume traded.
Concerns Raised by the Market
- Liquidity Concerns
- Brokers, proprietary desks, and institutional traders are fearing that the market will become less liquid and wider bid/ask spreads would greatly inflate the cost and inefficiency of trading.
- Most directly affected would be large trading desks (prop desks, HFTs, FPIs).
- Impact on Hedging
- A gross limit protocol might enfeeble the hedging program of big funds on their portfolios, which in turn could jeopardize market operation.
- Risk Management Being Contradictory
- Itself, buying and selling of options across different strike levels is another way of reducing risk.
- By instead summing long and short deltas separately, this gross limit proposal will actively contravene this risk reducing principle.
SEBI’s Response & Next Steps:
- SEBI is willing to accept that risks are not covered only by delta, and pointed out volatility and time decay as some other variables.
- Instead of having different limits on many parameters, it sees gross limit setting as a simplified risk management device.
- It seems that a review is on the way and is likely to amend the proposal depending on the feedback from the industry.
Gross limit proposes a tremendous concern in the direction of liquidity in the market, cost of transactions, and flexibility to hedge on index options trading.
SEBI intends to curb manipulation and control systemic risk; however, the intricacies of market dynamics and unforeseen ramifications could be pushing the regulator toward a redoing of the proposal.
Source: Mint
