The Securities and Exchange Board of India (SEBI) has proposed significant changes to the way outstanding positions in stock futures and options (F&O) are calculated, aiming to reduce the risk of manipulation in the derivatives market. The move comes amid growing concerns that certain influential market participants, leveraging advanced technology, may be engaging in manipulative trading practices in India’s expanding F&O segment.
In a consultation paper released late on Monday, SEBI suggested modifications in the calculation of Open Interest (OI) and Market-Wide Position Limits (MWPL). Open Interest refers to the total number of outstanding derivative contracts in a stock, while MWPL represents the maximum allowable positions in stock derivatives. The proposed changes include implementing stricter monitoring mechanisms, ensuring more frequent assessments of outstanding positions throughout trading sessions.
By tightening these regulations, SEBI aims to enhance market transparency and prevent unfair advantages that some technologically advanced firms may have over other participants. The regulator’s proposals reflect an effort to maintain market integrity and ensure a level playing field for all investors in the derivatives space.
Rajesh Palviya, Head of Technical and Derivatives Research at Axis Securities, suggested that SEBI may have observed instances where certain market participants strategically build up positions in stock derivatives ahead of key corporate announcements. By doing so, they may attempt to breach the market-wide position limit (MWPL), which leads to the stock being placed under a trading ban. During this ban period, no new positions can be created, and traders are only allowed to reduce or close their existing positions.
Palviya noted that such practices could be used to influence market dynamics, restricting fresh participation in specific securities until the pre-existing positions are squared off. However, with SEBI’s proposed changes, it will become more challenging for traders to engage in such tactics. The new mechanism, which includes tighter monitoring and revised calculations of Open Interest (OI) and MWPL, is expected to improve market discipline and prevent potential misuse of derivatives trading rules.
In the stock derivatives segment, a contract enters a ban period when the total outstanding positions in that stock reach 95% of the market-wide position limit (MWPL). Once this threshold is crossed, traders are restricted from taking new positions in that particular derivative contract. During the ban period, market participants are only permitted to reduce or square off their existing positions. The restrictions remain in place until the outstanding positions come down to 80% of the MWPL, at which point normal trading activity can resume.
A brokerage firm representative, who preferred to remain anonymous, shared insights into SEBI’s proposed changes to the way Open Interest (OI) in stock options is calculated. According to the broker, the regulator has introduced a weighted methodology, where different stock option contracts are assigned varying levels of significance based on how far they are from the current market price. This adjustment is expected to provide a more accurate reflection of market participation and prevent potential manipulation in the derivatives segment.
Proposed Changes Aim to Reduce Manipulation in Derivatives Trading
SEBI’s proposed reforms in the calculation of Open Interest (OI) are expected to limit opportunities for market manipulation. One of the key changes involves adopting a Delta-based or Future Equivalent approach for measuring OI in stock options.
Currently, all options contracts—regardless of their strike prices—are treated equally in OI calculations. However, under the proposed system, options that are farther from at-the-money (ATM) strikes (the current market levels) will be assigned less weightage in OI calculations. This means that contracts with lower market relevance will have a diminished impact on the overall outstanding position count.
Explaining this shift, Chandan Taparia, Head of Technical and Derivatives Research at Motilal Oswal Financial Services, stated that this approach aims to provide a more accurate representation of market positions and reduce the potential for manipulation. By focusing more on liquid and actively traded contracts, the new methodology is expected to enhance transparency and efficiency in the derivatives market.
Chandan Taparia emphasized that the proposed changes would lead to a more accurate and fair adjustment of open interest (OI) calculations for both stock and index options. By assigning different weightages to options contracts based on their proximity to the at-the-money (ATM) level, the revised methodology would ensure that OI figures better reflect actual market activity.
A broker, who wished to remain anonymous, noted that this adjustment would make it more challenging for certain market participants to artificially drive the market-wide position limit (MWPL) of stock derivatives toward the 95% threshold. Currently, when OI reaches this level, the stock enters a ban period, restricting the creation of new positions. Under the new system, the ability to manipulate OI calculations to trigger such bans would be significantly reduced, thereby promoting greater market integrity and transparency in the derivatives segment.
SEBI’s Proposed Changes Aim to Reduce Trading Bans and Enhance Market Stability
According to SEBI’s consultation paper, there were 366 instances of stocks entering the ban period in the derivatives segment between July 1, 2024, and September 30, 2024. However, under the proposed regulatory changes, this number would have been significantly reduced to just 27 instances during the same period. This suggests that the revised methodology for calculating Open Interest (OI) and Market-Wide Position Limits (MWPL) could substantially decrease the frequency of trading restrictions imposed on stock derivatives.
Additionally, SEBI has proposed a reduction in the MWPL for stock derivatives. Currently, the MWPL is set at 20% of the underlying stock’s free-float market capitalization. Under the new framework, this limit would be reduced to 15% of the free-float market capitalization or 60 times the Average Daily Delivery Value (ADDV) of the underlying stock—whichever is lower. The ADDV represents the average daily value of shares actually delivered in the cash market. By implementing this change, SEBI aims to align position limits more closely with actual market liquidity, ensuring a more stable and transparent trading environment.
SEBI Proposes Stricter Monitoring and Structural Reforms in Derivatives Trading
As part of its effort to strengthen oversight in the futures and options (F&O) segment, SEBI has proposed tighter monitoring mechanisms to ensure compliance with position limits. According to the regulator, clearing corporations of stock exchanges will be required to monitor whether traders are adhering to prescribed position limits at least four times during each trading session.
Market experts believe this increased scrutiny will help prevent excessive position build-up by larger trading firms, which often engage in aggressive strategies throughout the day. By curbing such activities, SEBI aims to reduce unnecessary volatility in the market, particularly the kind that arises from speculative trading in derivatives.
Rajesh Palviya, Head of Technical and Derivatives Research at Axis Securities, highlighted another key proposal—the introduction of pre-open and post-closing market sessions for derivatives trading. He explained that these extended sessions would allow for better price and premium discovery, aligning the derivatives market more closely with movements in the cash (equity) market.
In addition to these measures, SEBI has suggested revising position limits for different market participants—including brokers, foreign portfolio investors (FPIs), and mutual funds—for trading in single-stock derivatives. Furthermore, the regulator has proposed new eligibility criteria for derivatives contracts on non-benchmark indices, such as sectoral and thematic indices. This change could encourage the introduction of more sector-specific derivatives, expanding the range of instruments available to market participants.
Through these reforms, SEBI aims to enhance market transparency, reduce undue volatility, and ensure a more structured and fair trading environment in the derivatives segment.