What Is an Index Option?
An index option is a financial derivative that gives the holder the right (but not the obligation) to buy or sell the value of an underlying index, such as the S&P 500 index, at the stated exercise price. No actual stocks are bought or sold. Often, an index option will utilize an index futures contract as its underlying asset.
Key Highlights:
- Concerns of the Brokers
- Dryness of the limit would reduce liquidity in the market.
- Costliness to trade as the bid ask spread is likely to widen.
- Bid ask spread
- Difference between highest price, the buyer is willing to pay (bid), and lowest price, a seller accepts (ask).
- Loss of liquidity is what brokers expect, leading to costs that clients suffer from.
Responses and Feedback from SEBI
- SEBI received close to 1,000 responses, most against the gross limit proposal.
- Regarding market raving, those changes welcomed carrying delta measurement into open interest (OI) based calculations.
- It shall review the comments received and consider the possibility of amending the gross limit proposal from its current form.
Delta Based Open Interest Calculation
- Delta is a measure of change in an option price for every one point change in the underlying asset.
- For example: If the Nifty moves by Re.1 and the price of the option moves by 50 paise, then delta = 0.5.
SEBI’s Justification
- SEBI justifies that risk from options derives not just from delta but also from volatility and time.
- SEBI wishes it would not complicate matters putting limits to each parameter.
- Impact on Large Traders
- A broking firm official noted that large funds could not hedge their portfolios effectively under the gross limit rule.
- Reportedly, most brokers opposed a gross limit of ₹1,500 crore at the end of the day.
- Impact on Trading Desks and Institutions
- Gross limits would put an obstacle in the way of proprietary trading desks (prop), of high frequency trading (HFT) firms and foreign portfolio investors (FPIs).
- This could lead to a huge dip in volumes of trades, though estimates differ regarding that impact.
Thus, strong feedback from the industry would lead SEBI to amend its position regarding gross limits.
This debate brings to light the conflicting principles
