Market participants up in arms against exclusion of stocks from derivatives

A Sebi circular of 11 April last year proposed an enhanced eligibility criteria for stocks to trade in the futures and options (F&O) segment (Reuters)

Mumbai: In the largest such exclusion drive in the recent past, the National Stock Exchange, late on Monday, said derivatives trading will not be allowed in 34 stocks after their existing monthly contracts expire on Jun 28.

“Out of a universe of 1900 stocks only 159 will trade in derivatives. This will reduce liquidity and volumes. What will be left to trade if this continues,” said a mid-sized proprietary trader.

NSE’s move came as the stocks have failed to meet the Securities and Exchange Board of India’s enhanced eligibility criteria for stock derivatives.

In a bid to dissuade retail investors from the derivatives market, SEBI has brought about a slew of regulatory changes, including physical delivery of futures contracts of a stock and tighter norms on net worth. SEBI has been trying hard to regulate the Indian derivatives market, which accounts for most if not all the trading volume on Indian exchanges.

As part of the regulation, SEBI last April issued revised guidelines to determine whether a stock was eligible for trading in the derivatives segment. Under the new, stringent guidelines, F&O securities will need to have a market-wide position limit of 500 crore, up from 300 crore earlier, and a median quarter sigma order size of 25 lakh.

The new guidelines will ensure that F&O stocks with very low liquidity, and in some cases no liquidity, are driven out of the futures & options segment to keep speculators and price manipulators at bay.

Brokers through Association of National Exchange Members of India (ANMI) will send representation to SEBI saying the new guidelines will have an adverse impact on liquidity and volumes, said an ANMI member.

“Instead of fostering growth in the markets and integrating cash and F&O segments, SEBI has enhanced the eligibility criteria. This under the new physical settlement regime is becoming a self-fulfilling prophecy of lower volumes and higher spreads, thereby making stocks ineligible for derivatives,” said an ANMI member who did not wish to be named as they are yet to send their representations to the regulator.

SEBI had also mandated physical delivery of stocks in a phased manner. The first 50 stocks with smaller market capitalisation were to move towarda physical settlement by April this year, the next 50 in July, and the next 50 by October.

It is not just ANMI and brokers who believe that the enhanced criteria for F&O are hampering the segment.

NSE in the past one year has made several representations to the regulator on relaxing the criteria and permitting higher number of stocks to trade in derivatives. According to NSE’s representations, a copy of which has been reviewed by Mint, single stock derivatives should be introduced on top 500 securities.

“A liquid and robust derivatives market induces liquidity in the underlying cash market,” said a person familiar with the exchange’s thinking.

“Globally most markets allow derivatives contracts on single stocks without any restrictions. Both in the US and Europe more than 2000 securities have derivatives contracts. Now that Indian markets are moving towards physically settled derivatives contracts for individual stocks it may be prudent to introduce derivatives contract on more single stocks,” said NSE in one of their representations.

Rajesh Baheti, Managing Director of Crosseas Capital Ltd mirrors NSE’s views. “When SEBI proposed compulsory physical delivery of stocks we welcomed it. We believed that with this, more and more stocks would be admitted to trade in the F&O segment. SEBI, rather than relaxing criteria for stocks, made it stricter, thus creating a situation where stocks are becoming illiquid and eventually going out of F&O segment,” said Baheti.